It is true – Forex brokers do not charge a commission. Investors who are used to trading on the stock market will find this concept unbelievable, but rest assured this does not mean that a broker on the Forex market makes no money.

Forex Brokers - No Commission

Forex brokers make their earnings from the spread. Brokers act as the purchasing agent for an investor by executing trades either from the market maker offering currency pairs or from another broker. The price the market maker buys currency pairs is the bid price, whereas the price for selling is referred to as the ask price.

Let’s use this pairing as an example: EUR/USD 1.1900/05. Buyer purchases 1 EUR for 1.1905 USD; seller sells 1 EUR for 1.1900 USD. This difference in this trade is 5 pips or 1/100 of a currency unit. 100 lots were traded (100 x 100 000 units of currency). The broker’s spread is /250.

The difference in the trade is referred to as the spread, the number which generates a profit for market makers and Forex brokers.

Undestanding The Spreads in Pips

What does the broker do for his money? He or she acts as an intermediary between market maker and trader. The broker’s job is to find the seller and the buyer who will move the currency pairs at the price designated by the investor. The investor is the one who gives up the spread to the broker, thus paying his wages.

In the example used above, the seller sold euros at 1.1900, or 5 pips less than the buyer who purchased at 1.1905. 1.905 is the spread in this trade. The buyer does not know whether he realized a gain or a loss until his pairs are actually sold. If the buyer and seller are the same person, in this particular trade, the investor has lost $5,000. Since the broker leveraged 1/250, he or she is paid that percentage of the loss, or $20. This is simply the cost of trading in currency pairs and how the broker earns an income.

In order to realize a profit, the investor must see the exchange rate rise more than the amount of the spread he is going to owe to the broker. Of course, it could also swing in the other direction and the loss would be greater if the position is liquidated.

There is money to be made in trading on the Forex market in currencies, but every investor needs to realize the costs involved in order to make a trading decision which will result in a profit.