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How do Forex brokers make their profits?

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They take a cut on the spread.

If the spread between the buy and sell is 1.5 they charge 1.51 so they make .01 on each transactions

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Currency Trading For Dummies

 

  • What is the commission structure? Most online forex brokerages provide trade executions without charging trade commissions. Instead, the broker is compensated by the price spread between the bid and the offer. A few brokers offer a commission-based pricing structure coupled with narrower trading spreads. If the brokerage charges a per-trade commission, you need to factor that cost into your calculations to see if it’s really a better deal than a spread-based commission.

http://www.dummies.com/how-to/content/currency-trading-for-dummies-cheat-sheet.html

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Forex brokers: ECN vs STP vs NDD vs DD
Dealing desk versus No dealing desk order processing

DD — Dealing Desk — Forex brokers that operate (route orders) through the Dealing Desk and quote fixed spreads. A dealing desk broker makes money via spreads and by trading against its clients. A Dealing Desk Forex broker is called a Market Maker - they literally "make the market" for traders: when traders want to sell, they buy from them, when traders want to buy, they sell to them, e.g. they will always take the opposite side of the trade and in this way "create the market". A trader doesn't see the real market quotes, which allows Dealing Desk brokers (Market Makers) manipulate with their quotes where they need to in order to fill the client.

NDD — No Dealing Desk — NDD Forex brokers provide access to the interbank market without passing orders trough the dealing desk. With true No Dealing Desk brokers there are no re-quotes on orders and no additional pausing during order confirmation. This, in particular, allows trading during news times with no restrictions on trading.
An NDD broker can either charge commission for trading or choose to increase the spread and make Forex trading commission free.
No Dealing Desk brokers are either STP or ECN+STP.

STP — Straight Through Processing — STP Forex brokers send orders directly from clients to the liquidity providers - banks, which trade on the Intebank. Sometimes STP brokers have just one liquidity provider, other times several. The more there are banks and liquidity in the system, the better the fills for the clients.
The fact that traders have access to the true market and can execute trades immediately without dealer intervention is what makes the platform STP.

ECN — Electronic Communications Network — ECN Forex brokers additionally allow clients' orders to interact with other clients' orders. ECN Forex broker provides a marketplace where all its participants (banks, market makers and individual traders) trade against each other by sending competing bids and offers into the system. Participants interact inside the system and get the best offers for their trades available at that time. All trading orders are matched between counter parties in real time. A small trading fee - commission - is always applied.
Sometimes STP brokers are discussed as if they were ECN brokers. To be a true ECN, a broker must display the Depth of the Market (DOM) in a data window, let clients show their own order size in the system and allow other clients to hit those orders. With ECN broker traders can see where the liquidity is and execute trades.
Broker types and revenues: fixed vs variable spreads vs commission

ECN Forex brokers always have variable spreads. Only ECN brokers charge commission for trading Forex. Commission is the only revenue/profit an ECN broker receives. ECN brokers are not making money on bid/ask (spread) difference.

An STP Forex broker is compensated through the spread (spread markups - to be explained in details below).

STP brokers have a choice of offering variable or fixed spreads. STP brokers route all trading orders to the liquidity providers - banks. These brokers, as intermediaries between their clients and banks, receive prices (spreads) posted by the banks on the Interbank market. Most banks, in fact, offer fixed spreads.
An STP broker therefore has 2 options:
1. Let spreads be fixed.
2. Leave the spread at 0 and let the system take the best bid and ask from the number of banks (the more the better) and in this way provide variable spreads.
How an STP broker earns its money? Since STP brokers (as well as ECN) don't trade against their clients, they add own small markups to the spread quote. This is done by adding a pip (or half a pip, or any other amount) to the best bid and subtracting a pip at the best ask of its liquidity provider. All client orders are directly routed to the liquidity providers at original spread quoted by those providers while an STP broker earns its money from own markups.

Forex market maker - a broker with a dealing desk earns money on bid/ask difference as well as when a client loses a trade, since market makers are trading against their clients by hedging - entering in an opposite trade.
Conclusion:

ECN brokers are the purest breed among all Forex dealers. They don't profit on spread difference. Their only profit comes from commission. ECN brokers are interested in their clients to be winning, otherwise there will be no commission to earn.

STP brokers make money on spreads, thus even though they do not have a physical dealing desk to monitor and counter-trade client orders, they are still able to set their own price - the spread markup - for routing trading orders to liquidity providers and providing their clients with advanced trading services, lower account deposits, faster execution and anonymous trading environment with no dealing desk. STP brokers are also interested to see their clients trading profitable, so that a broker can continue earning on spreads.

Market makers make money on spreads and by hedging against their clients. However, if a client becomes "too" profitable, it can directly "upset" the broker. While this may be tolerated and professionally managed by a larger reputable market maker, with a smaller dealer such client will be soon asked to leave.
Benefits of trading with No Dealing Desk brokers

Among the main reason why traders look for NDD brokers is transparency, better and faster fills and anonymity.

Transparency means that a trader enters a true market instead of the market being artificially created for him.
Better fills are a result of the direct and competitive market bids and offers.

Anonymity means that there is no Dealing Desk watching who has come to the market and is asking for an order to be filled, instead client orders are executed automatically, immediately through the market network and totally anonymously.

On the opposite side is a Dealing Desk broker, who is able to profile their clients. In the worst case scenario, such broker can split clients into groups and put less successful ones on auto-execution and trade against them because on average they will lose, while clients that show signs of successful trading will be put on "slow-down" mode and can be provided with frequent re-quotes, slippage and/or slower execution especially during fast moving markets while a broker tries to offset own risks. The transparency of a Dealing Desk broker depends on the rules inside the company.

Forex Brokers aren't bad on general, whether a Dealing or Non-Dealing Desk, they aren't there to be against any particular trader. They look to make business, not just work for traders in terms of cooperation in the market environment. Many large Forex brokers who have lots of clients tend to try to help their clients become profitable as much as they can, but once a trading order is placed, its everyone for themselves.

 

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VX is correct, I'm a trader for 10 years, and what he posated is 100% correct.

Bucket shop brokers (small American outfits) hold your trade themselves, and hope  you lose. They survive because they balance your buy trade against Bobs sell trade, and if their book gets too outa whack on a pair, they lay off with a liquidity provider.

True ECN brokers pass your trades directly into the interbank market... but if you are trading in say $1 or $2 lots, they;lll likely put your trade in their bucket.

 

If you are trading $10 lots and above with an ECN broker you can rest asuured your trade is straight thru to the Interbank market.


there are bucket shop brokers outside America that will offer you up to 2,000 and 3,000:1 leverage... in other words, you can open an account with just $50, and bet in lotsizes as low as 1 cent.

However, they place a $250 to $500 limit size on your account.

If your account goes above their limit, they automatically reduce your leverage to about 500:1... if you are not careful, that can margin you out.

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