In any given foreign exchange market (Forex or simply FX) transaction there are three main players: the buyer, seller, and the broker. Buyers and sellers are typically individual investors, institutional investors, banks, or government entities. Forex brokers are the intermediaries that handle the transactions between buyers and sellers. The Forex broker is functionally no different than a broker dealing in stocks, commodities, and other types of securities.
Brokers play an important role in currency transactions because they make such transactions available to all sorts of investors. Prior to the early 1940s currency trading was limited to government institutions and large banks. But as the market became more open to individual investors the need for brokers exploded. Today there are several different kinds of Forex brokers catering to the needs of different types of investors.
How Brokers Make Their Money
A Forex broker makes their money in one of two ways: charging a commission for every transaction or taking the opposite position of a trader. The first method is by far the most common and the easiest one for the new investor to keep track of. By charging a commission for each transaction the broker helps the trader know up front how much each trade will cost. It’s also a great way for the brokerage firm to make sure it makes money on every trade regardless of win or loss.
When a broker employs the method of taking the opposite position, the firm is hoping the customer has taken the wrong position on any given currency. When the customer loses on a given transaction the broker gains, and vice versa. This type of system is a bit more risky for both broker and customer, but the potential for pay-offs on both sides is much greater. Before using a broker that takes this approach you should be sure you know what you’re doing and that you’re willing to lose a certain amount of money on a bad deal.
In the end, a Forex broker succeeds when both buyers and sellers succeed. Therefore, they also provide as much information as they can to help investors make wise choices. The typical Forex broker offers real-time news, analysis, and daily wrap-ups to help you prepare for the next day’s trading. If you can hook up with a broker that works well for you, you’re a step ahead of the competition.