How Brokers Make Money - Beware Of These
Often as a Forex trader, the first thing you want to do is just make money without really looking at the reasons why you may not be making money, or rather the reasons for losing trades.
Now, don’t get me wrong it is vital to focus your attention on having great winners, but it is equally important to focus on the small losses because those small losses can change to great winners if you pay attention to the errors you make or the small ways in which brokers could be eating away at your profits…
That is what we will be addressing in this article. How Brokers make money from Forex traders and what Forex traders can do to minimize this.
It is important to understand that you get market makers; these brokers bring the asset or currencies to the investors or traders. Financial institutions and banks act as market makers because they provide the liquidity required to place trades.
For a broker to be legit, they must be registered with a Financial Services Provider/Board in a certain jurisdiction. Usually, this is not an easy process, however, many brokers will choose countries where approval is easier.
Brokers who take the easy road want uneducated traders to open live accounts and place trades so they can profit.
A good broker has insurance that covers traders’ capital so that if the registered broker goes bankrupt, the traders’ capital is protected and the Forex trader is able to get their capital back securely.
Let us look at a couple of ways brokers make money besides the obvious commission or spread on the market price. I must also mention that authentic brokers shouldn’t be adding their own massive spread to the one given to them by liquidity providers, but I’ll dive deeper into that point in my second point of this article.
Stop loss Hunting
(Source – TradingView)
Pay attention to the sizes of the wicks that I’ve placed in rectangles. In this example, the wicks were more than 100 pips!!! When the broker is responsible for this, they make money off of the trades you lose (picking up liquidity like the banks).
Remember I said I’d come back to brokers unnecessarily adding spread on top of the liquidity providers spread?? I say that because you get two types of traders – Retail traders (the ordinary people trading from home) and institutional traders (your hedge funds and banks).
These are differentiated by aspects such as the regulations and requirements to be either retail or institutional investor.
Institutional traders can place their trades directly with the liquidity providers, whereas the retail trader cannot do that. He or she needs a broker to facilitate that order.
Now, the brokers’ only job is to ensure that the order is placed at the time the Forex trader executes it and at that particular price. Meaning they should transfer the trade. However, to make more money (out of greed in my opinion), they place a spread on the price.
For example, liquidity providers may have a spread of 0.5 pips on EUR/USD, but your broker may add 1 pip on that. So instead of having a spread of 0.5 pips, you have a spread of 1.5 pips. This may seem small to some Forex traders, except it is not when accompanied by my next point. Uneducated traders can get sucked in, FAST!
Leverage can be your best friend, or it can be your worst enemy – depending on how you use it. The best brokers in the world don’t have outrageous leverages like 1:2000 because they are in the business of making it safer for the client.
So in your efforts to find a broker that works for you, understand that you will find brokers that are out to cheat the average Forex trader. You can avoid this if you are well informed about these tactics, and you can look for another broker to keep your money safe.
As you can see from all the points discussed, it is crucial to choose a great broker that keeps your needs in mind. We suggested your trade with one of our top 3.
I wish you all the best in your trading journey!
Happy trading Traders!