The Rates Forex Brokers Charge
One point that makes forex trading appealing to people is the lack of commission payments to the brokers. While you are not paying a commission you do have to pay the forex brokers in some way because these are not charitable organisations. Forex brokers make their money through the spread they offer on a trade. It is important that you understand the three ways these spreads are calculated to ensure you are getting a fair rate.
What is the Spread?
Before you can look into how you are being charged you need to know what the spread is. The spread is the difference between the asking and selling price of a currency pair. When you trade with a broker you receive 2 prices for the currency pair you wish to trade. The prices change depending on the market and in many cases the spread will change as well.
Forex Brokers with Fixed Spreads
One way that forex brokers charge commission is through a fixed spread. These spreads remain the same regardless of the market volatility and liquidity. The spread is displayed in pips and can range from 1 pip to 5 pips or more. The lower the amount of pips the better the spread is for you. The fixed spreads are not used very often because of the volatility of the market and the need for brokers to make profits throughout the year.
The most common commission structure used by forex brokers is the variable spread. In this scheme the spread can vary from 1 pip to 5 pips depending on the market. The more volatile the market the higher the spread will be because the broker is looking to make more money. Of course, there are also certain times of year when there is little movement on the market and the spread will increase. Brokers do this to ensure they make a profit on the trades that do take place during these times.
Commissions based on a percentage of the spread are not often seen in retail trading. Financial institutes generally use this scheme because of the high volumes being traded. With this scheme a very low commissions around 2/10 of a pip is charged per trade. The only way that this scheme is profitable for the brokerage is when large lot sizes are being used. Retail traders do not use lot sizes large enough to justify the brokers adopting this scheme.
Are you Getting a Fair Rate?
Once you know what spread commission your broker is charging you can determine whether or not you are getting a fair rate. The best way to determine this is to get a track record of the spreads for a period of time from a number of brokers. You can then compare the rates and see where your broker falls.
Larger brokerage firms generally offer better spreads because they have direct access to the forex market. The problem is that most retail traders are not able to use these brokerage firms because of the large capital and volume they require.