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by: Mohammad Hafiz

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There are several ways Forex brokers earn their money. These include commissions, spreads, dealing and theft. Of these, only commission-based brokers are certain to be indifferent to your trading results, as they get paid whether your trades win or lose. The other three ways are all subject to possible abuse. We can clarify the benefits of commission-based brokers by contrasting each non-commission type with the commission model of revenue generation.

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Commission-Only Brokers

Forex trading is a zero-sum game: one counterparty to the trade wins, the other side loses. Brokers who only charge commissions do not assume the role of counterparty to customer trades, and thus have no reason to manipulate prices or spreads to the customers’ disadvantage. With a commission-only broker, you are buying peace of mind. These brokers charge either a flat fee or a fee based on the size of the trade. Higher commissions are charged by electronic communications network (ECN) brokers, who provide extra services: real-time trade execution with the largest audience of counterparties, and access to bid/ask orders piled up on either side of the last trade. This bid/ask data can help savvy traders precisely pinpoint their market entry and exit points.

Spreads

A spread is the difference between the bid price (what a buyer would be willing to spend) and an ask price (what a seller would be willing to accept). It is measured in pips, or points in percentage; each pip is equal to about $10, depending on the currencies involved. There is an intrinsic spread in the Forex interbank market that varies during the day from zero to five or more pips depending on the currencies being traded. Two types of brokers charge spreads. The first, termed a straight-through-processing (STP) broker, like the ECN broker, does not assume the role of counterparty. STP brokers increase intrinsic spreads to earn revenue on trades, and they may or may not also charge a commission. The second type, a dealing desk, does trade against customers and can manipulate spreads to its advantage.

Dealing Desks

Dealing desk brokers, also known as market makers, set up an in-house trading desk that assumes the other side of a customer’s transaction. They charge fixed spreads – ones that do not reflect the current intrinsic spread. By manipulating the bid/ask spreads they offer and the prices they quote for different currencies, dealing desks have a powerful trading advantage over their customers. Dealing desks must constantly fight the temptation to gouge their clients with inflated spreads and/or manipulate prices to cause customer trading losses.

Bucket Shops

The worst members of the broker community are called bucket shops but are actually thieves. They collect traders’ collateral but never actually buy or sell foreign currencies. Their trades are all on paper, giving them use of trader collateral that should be securing a real, not paper, trading position. Strictly illegal in the United States, bucket shops do exist around the world and are to be avoided at all costs.

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Related Searches

References

MQL4 Forum: Forex brokers: ECN vs STP vs NDD vs DD

FXStreet. Com: The Importance of Technology in the Forex Broker Selection Process

FXHelpline: Keep Your Friends Close, Keep Your Forex Broker Closer

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