How Forex Brokers Make Money: Spreads & Hidden Fees

Your broker makes money from you when you open a trade. This happens even before you come into any profit or loss. How you read a trading account differs once you understand how forex brokers make money.

It can help you in selecting a broker and working out your actual trading expenses. Win rate and strategy are most of the traders’ targets. People avoid the fee structure, which sits below each position they open.

How Forex Brokers Make Money With the Spread

The bid-ask spread on a currency pair is the difference between the bid price and the ask price. Buy EUR/USD at 1.1002 and sell at 1.1000. That two-pip difference is the broker’s to keep the moment you trade. This is the main source of income for Forex Brokers. A spread is charged on almost all retail trades, regardless of platform type or account.

Fixed vs. Variable Spreads

Spreads come in two varieties: fixed and variable. A fixed spread is always the same, no matter what the market conditions are. It gives you a clear, predictable cost, and it can be wider than the average variable spread during calm conditions.

A variable spread fluctuates along with liquidity and volatility. During a major news event, the spread on a major such as GBP/USD can be as big as 10 pips or more in seconds. That’s a direct cost to those trading based on the news.

Why Spreads Vary Among the Currencies

Spreads will also be different for pairs. The spreads are low on pairs that are more liquid, like EUR/USD or USD/JPY. Generally, traders seeking a low-spread account will find that the tightest spreads are on these majors, as exotic pairs like USD/TRY or USD/ZAR are less traded and have a wider price spread.

Almost always, a broker offering a ‘0.0 pip’ account on majors will offset this pip spread with an additional commission. A headline spread number is not necessarily enough on its own to tell the entire story.

Commission Fee

Some types of accounts have high commission fees and spreads. This is the typical way that ECN and raw-spread accounts operate. The spread stays fairly close to the interbank spread, usually less than a pip on majors. The broker then takes a flat rate for a standard lot, typically from $3 to $7 per side.

Commission Accounts

This structure is attractive to high-volume traders and scalpers. It reduces the noise of the market price and the cost of the trade, allowing you to better observe how brokers earn from your volume and not the price.

An account that does not display any commission is likely to include an equivalent cost in a broader spread when the trader is using a market-maker account. Commission-based accounts are not necessarily less expensive. All-In-Cost (Spread plus Commission) is more important than other numbers.

Swap Rates

Hold a position open through 5 p.m. New York time, and your broker applies a swap. This is also known as rollover interest. It’s based on the interest rate difference between the two currencies in your pair.

It’s possible to earn a small credit by purchasing a currency that has a higher interest rate for a currency that has a lower interest rate. Do the opposite, and you pay a debit every night the position is held open.

How Swap Costs Add Up

Swap rate changes are in sync with the central bank policy. The Interbank rate is the base rate on which brokers apply a “markup” and then on top of which they charge broker fees, which are not always disclosed in marketing literature.

A trader who trades with a timeframe of a week may easily lose a significant amount of potential gains through the swaps without even realizing it. This is particularly the case when the difference between the pair rates is large, such as USD/TRY or USD/MXN. Rollovers are usually x3 for the weekend, so a trade that is open on Wednesday is charged 3 times the overnight fee.

Trading with a Market-Maker in the OTC Market

Another way forex brokers earn money is in the way they execute orders for you. A market-maker broker isn’t connected to an external liquidity provider and instead makes a market in the asset. If you lose, the broker makes a direct gain.

This situation results in a conflict of interest. Regulators in other countries like the UK and Australia mandate disclosing it, but it can be found in the terms and conditions that most traders tend to ignore.

Rebate Model

Other brokers will forward orders to liquidity providers and receive a small rebate for the orders they send. This is more prevalent in the equity and options markets, yet it is also found in the forex market. This rebate model can impact order routing decisions, which are not always apparent to the end trader.

All of this is not to say that market-maker brokers routinely defraud their customers. However, it’s an incentive system that’s still not quite like an agency broker who makes a spread or commission, irrespective of the result of your trading.

Withdrawal Fees, Inactivity Charges, and Currency Conversion

These lower, secondary fees may appear insignificant initially, but they can mount up rapidly and have a serious influence on a trader’s profits.

For instance, some brokerages offer a fixed rate for each cash-out, some pass the fees charged by third parties directly on to the user, and some are super cheap but do not disclose third-party fees, so they can rank higher on review sites.

Longer-term traders should also be aware of the inactivity fees in the fine print, which typically start after 90-180 days of no trading. Not to mention, the markups for conversion from currency to currency on top of that will give an extra 0.5% to 2% per transaction.

These secondary costs are not normally factored into a broker’s standard trade confirmation receipts, so are important to consider when estimating a broker’s average earnings per client.

In Short

A broker’s revenue model is based on stacked layers, such as spreads, commissions, overnight swaps, order flow payments, and these lesser-known administrative charges. It is very important to check and review a firm’s full fee schedule and check out other independent comparisons before putting money into a live account, so as not to have unwanted friction against your capital.