No matter what financial market you are active in, brokers play a substantially important role for the traders and investors involved in them. They make it possible for ordinary people all the way to large organizations to have access to the financial markets.
The same is true for the foreign exchange market. In this market, forex brokers make it possible for you to access this market and be able to trade foreign currencies.
But that is only a rudimentary explanation of a forex broker. What we intend to do in this article is to take a much closer look at forex brokers to see who they function, how they make money, and how forex traders can choose the best broker for their trades.
What Exactly Is a Forex Broker?
To find out exactly what a forex broker is, let’s first take a look at what forex trading is.
The mere activity of forex trading is making speculations regarding the price of foreign currencies against one another. This is what is known as a currency pair. In any currency pair one of them is the base currency and the other is the quote currency. So in this way, you are not buying the foreign currencies in actuality. Rather, you only guess, or speculate, regarding their value in comparison with one another.
For example, in the well-known and widely used currency pair of EUR/USD, you make speculations regarding the value of the pound Sterling against the United States dollar.
Now, to make all this speculation on the value of foreign currencies, you need a platform to do so. This platform is provided through a forex broker to the traders.
So in more precise terms, a forex broker would be an organization or a company that makes it possible for traders to buy and sell, or rather go long or short on foreign currency pairs.
There are so many forex brokers out there providing their services to traders. So it can be a rather challenging experience to choose the best one. Not to worry, because in this article we are going to show you exactly how you can pick the best broker.
A Closer Look at Forex Brokers
The foreign exchange market is the largest financial market in the whole world. With trillions and trillions of dollars being traded all the time, forex brokers carry a heavy burden.
But you need to know that brokers do not only deal with individual traders. In fact, individual traders make up only a small portion of the trading volume that takes place in the forex market.
The fact is that the forex market is replete with other big players. Such as institutional traders, venture capital companies, and hedge funds that are trading foreign currencies on behalf of their investors with huge sums of money.
This tremendously huge volume of assets that are being traded in forex make it necessary for there to be numerous brokers. And indeed there are. Each broker is responsible for a position of this volume. And put together they make up the greatest financial market in the world.
But there are two utmost important questions left to answer.
First, what is it that brokers actually do? It is true that we mentioned they play an intermediary role between traders and the market. But clearly there needs to be more detail.
Secondly, how do they make money? What is in it for them?
In the following sections, we are going to answer both of these questions.
What Do Forex Brokers Do?
The role of brokers in all financial markets is so significant that we need to discuss in detail just what they do. But this time, with an example.
Back in the early 2000s, prior to the horrific 2008 market crash, a group of market experts and investors decided to short mortgage bonds. At the time, and to be honest even now, shorting mortgage bonds seemed like such a crazy idea. Nobody would actually do that. Because these bonds are backed by so many funds that it would be unreasonable to bet against them.
The improbability of betting against these bonds was even more prominent before the 2008 global market crash. So when these few investors decided to go short, brokers in the market had to actually create instruments through which this whole process would be possible.
So, would it be reasonable to say that without brokers we wouldn’t have witnessed the 2008 recession? If you look at the big picture, the answer is yes.
We wanted to use this example to further elaborate just how important the role of brokers is in financial markets.
How Do Forex Brokers Make Money?
But forex brokers do not facilitate the possibility of traders having access to financial markets out of the goodness of their hearts. There is actually money to be made.
There are two different ways in which forex brokers can make money.
The first one is through the bid ask difference, known as the spread. For instance, imagine a currency pair that has an ask price of $1.2 and a bid price of $1.3. When a trader opens a position at the ask price then closes it at the bid price, the difference between these two prices, or the spread, which is equal to $0.1 in this example, would be pocketed by the broker.
Second way brokers can make money is through different fees and commissions that they charge the traders. Fees including deposit fee, withdrawal fee, transaction fee, etc.
How to Choose the Best Forex Broker?
With so many different options available out there, it might be difficult to choose the best forex broker. But, there are certain features to keep in mind when deciding to pick a broker over another. Let’s go through some of them.
- Regulation: first of all, make sure that the broker in question is regulated by reputable agencies and entities. Brokers are usually registered in various countries and territories. So they are usually regulated by numerous legal entities.
- Leverage: another factor is the leverage that the broker can provide to traders. Leverage is of course a hugely important factor with any broker. Leverage can allow you to trade with much more than you actually have. In fact, this amount can sometimes be manifold and multiple times higher than your initial equity. Some brokers are able to offer a high rate of leverage, while others might not offer a suitable rate.
- Spread and Commission: we already talked about the notion of spread or the difference between the ask and bid prices. In the competitive market of brokers, they all try to hide their fees and commissions as much as possible. So, the spread is one place where you actually will always end up paying something. It is very important to check the spread available at a broker before picking the broker as your final choice.
- Deposit and Withdrawal: another area that can prove to be costly for traders if they do not pay enough attention are the fees charged for deposits and withdrawals. Again, because the market is competitive, there are brokers that actually charge nothing for deposits and withdrawals, while there are others that charge quite a bit. So make sure to check these two amounts.
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Forex brokers are the bridges that connect traders and investors to the attractive world of foreign exchange market. These are brokers that allow you to make speculations regarding the value of various currencies against others.