So far, we’ve learned about all the good things that Forex brokers can offer you, but, as you know, good things don’t often come for free, and it’s time to learn how Forex brokers make their money and what you should to pay for their services.
The good, the bad, and the ugly
The good – A forex trading account is one of the few things in life where you don’t have to pay upfront. Opening an account is free, and as long as you don’t fund it... the broker cannot require you to pay for anything. In fact is that you can “get away” with using the broker’s demo account
service without ever putting a cent into the real money account.
The bad – Once you do start trading with real money, it’s easy to accumulate small costs without even noticing. What’s more, there are huge differences between broker fees, and even when you do find a broker with relatively low spreads, they can change their fees structure without prior warning, and force you to go looking for another broker.
The ugly – Like any industry, there will always be players trying to squeeze out an extra penny out of the client using hidden fees. It’s very important to choose a broker who provides a very clear explanation about every single fee they charge - you don’t want to find yourself paying hundreds of dollars on things like “inactive account” fines.
The most basic and common way in which Forex brokers make money is by charging what is known as "spread". The spread is the difference between the buy price and the sell price of an investment instrument.
How big or small the spread may be is determined by the type of broker you are dealing with, and of course, the individual broker’s business model. As we’ve discussed earlier in Chapter 2,
different types of brokers are able to charge different ranges of spread due to their brokerage practices. "Market Makers", for example, can offer fixed spreads that are tighter than some of their STP
competitors because the prices they offer are independent of the prices in the interbank market.
Some STP brokers, however, can get even tighter spreads by aggregating price quotes from multiple banks, depending on their capitalization.
Spreads differ from currency pair to currency pair so when you’re looking at the spreads a broker offers, don’t look at the pairs with the lowest spread, but rather at the pairs that you’re most likely to trade. Currencies with more trading volume will usually have lower spreads, while more exotic pairs will have a higher spread.
How is the spread charged?
Spreads are quoted in pips
, which in terms of currency prices, is equal to 1/100th of 1% of the price. Usually a movement of one pip will be reflected in the last digit of the currency price, which is the fourth digit after the decimal point.
Whatever the spread may be, it will not appear as a “charge” on your account, it will simply be manifested as a difference between the price at which you buy the currency and the price at which you can sell it (or vice versa). So if, for example, a broker offers a 3-pip spread on EUR/USD it means that if you buy EUR/USD, at 1.2783 and wish to sell it immediately, the sell price will be 1.2780 and the amount that this difference takes off of your investment will go to the broker.
Fixed or variable?
It is considered that fixed spreads (offered by Market Makers
) are generally more advantageous for traders, since you know coming into the trade that you have to make up a predetermined amount of pips to break even. However brokers who charge variable spreads
can sometimes offer you tighter spreads as a tradeoff for a degree of uncertainty and the possibility of price slippage.
In addition to spreads, some brokers choose to charge commissions on currency trades, especially STP and ECN
brokers who are getting their spreads directly from the interbank market.
That means that you will pay the difference between the buy and sell prices, which exists already in the interbank price quote, and, in addition, you will pay the broker a small commission (around 0.25 pips) to pay for their service. In this case, the commission will be charged separately, either upon opening or closing the position.
Outside the realm of Forex trading, there are many other instruments for which brokers choose to charge commissions instead of spreads due to the way the instrument is traded on the exchanges. Stocks, for example, will often carry a commission charge somewhere in the realm of 0.1% of the invested amount simply because the stock exchanges only quotes one price, unless the stock is traded as a CFD.
All financial instruments have an interest rate
attached to them, which means that you accumulate interest for every day that you are holding them. In the case of currencies, because you are buying one currency and selling another, the broker sometimes has to pay the difference between the two rates... and sometimes the difference comes out in his favor.
This is why, in addition to spreads and/or commissions, some brokers charge overnight rollover to cover the additional costs they have to pay for your currency positions. On the other hand, if the difference comes out in the broker’s favor, the broker will usually pay out the difference to the customer.
Since the interest rates change periodically, make sure to keep tabs on your broker’s rollover fee list. You can usually find this list on the broker’s website, however, some brokers only show the rollover fee as you’re opening the trade. In that case you can ask your broker to periodically send you the list of rollover fees as it gets updated.
While most of the fees brokers exact come from trading, there can be additional fees involved in your relationship with your broker. These include:
Withdrawal fees – most brokers charge some form of withdrawal fee, if only to cover the fees it costs them to transfer funds from their account to yours.
Extra services –
brokers may ask you to pay for some of the services we’ve listed in Chapter 4
, such as trading courses, forex signals, market analysis etc.
Inactive account fees – this is a particularly nefarious practice, wherein a broker deducts funds from your trading account balance if you don’t use your account for a certain period of time. Make sure that your broker does not charge this type of fee.
Customer support – the practice of charging exorbitant call prices for using a support line is by no means exclusive to the Forex broker world, but unfortunately it’s not rare either. Make sure when you call support that the number you are calling is toll-free, or simply use chat.
In any case, to avoid surprises it’s definitely worth your time to contact your Forex broker and ask for a list of fees, including: spreads, commissions (if any), rollover, and any of the additional fees listed above. This way you will know exactly how much each action will cost you before taking it - and you will avoid the nasty surprise of discovering all those pilled costs on your account.