A guide to forex brokers
If you are thinking about investing or trading forex, then you will need a forex broker to help you gain access to the market. In fact, you may have already come across the term ‘broker’ while doing your research into forex. But what exactly does a broker do, and why do you need one? Here, we attempt to break down the role of an Australian forex broker, how they are compensated, and how to pick one that is best suited for you.
What is a forex broker?
Simply put, a forex broker is someone that works as an intermediary between you – the trader or investor – with the interbank system. Essentially, brokers provide access to a trading platform that allows them to buy and sell foreign currencies. Traditionally, they would buy and sell currencies on behalf of the trader. However, with the evolution of technology allowing for the rise of online forex brokers, traders can technically trade currencies themselves. Forex brokers can also be known as a retail forex broker or a currency trading broker.
There are two main types of forex brokers. These are:
- Dealing desk: These brokers (otherwise also called market makers) set fixed spreads for both buying and selling currencies. They tend to be used by institutional investors because dealing desk brokers create personal markets for their clients to trade in.
- No dealing desk: These brokers tend to analyse currency prices from a variety of financial institutions such as banks. They will then pass on the best one to their customers. These brokers are more common with individual and retail traders. This is because it is more difficult for retail traders to access the interbank and use that to make trades themselves.
A forex broker’s role
With regard to forex trading, most foreign exchange transactions tend to be between pairs of currencies. Brokers will therefore allow traders and investors to buy and sell these currencies. They essentially operate as a middleman between a customer and the market. So, in order to find a buyer or seller of a currency, forex brokers will help match traders with a respective seller or buyer. Additionally, forex brokers are also the middlemen between their customers and what is called a ‘liquidity provider.’ Liquidity providers tend to be financial institutions such as banks, that can take the other side of a forex trade.
Opening a forex account
To get a forex trading account, one must first contact a forex broker to do so. Aside from paperwork including filling out an application and sending in identify verification forms, forex traders will also need to deposit funds into a new account before they start trading. Fortunately, for those who are still not entirely sure whether they want to commit to forex trading, most brokers offer a demo or practice account. These accounts allow customers to practice their forex trading strategies without any risk. As the demo accounts simulate real-life market movements, it is a good way for novice forex traders to educate themselves on how the platform works, what features are on there, what to look out for in the forex market, and how to identify good opportunities for trading. Afterwards, traders can then move on to a proper account and start trading for real.
Aside from accounts, forex brokers also provide leverage to their customers. This allows traders to trade larger amounts for a fraction of the trading position’s cost upfront. This makes forex trading great for people who may not have a lot of funds, but still want to participate in the market anyways. That being said, leverage also amplifies risk – as traders need to pay back what the position size is worth, not just their initial small deposit.
How brokers are compensated
If brokers are supposed to be the middleman between traders and the market, how are they compensated then? Most forex brokers are compensated in two ways. The first way is through the bid-ask spread of a particular currency pair. The spread is the earnings between the market price and the price a trader paid. Another way brokers may be compensated is through additional fees. Some brokers may charge a fee for every transaction, or a monthly fee for their customers accessing a particular software. There may also be fees relating to special trading options or other financial instruments. Because fees can vary from broker to broker, it is vitally important traders read the fine print and compare costs and services before committing to a broker. Some fees you may want to keep in mind include inactivity fees (if a trader stops trading for a certain period of time), currency conversion fees, and account fees (mainly charged monthly or yearly to keep an account open).
How to pick a broker
Before committing to a certain broker, it helps to consider a few factors so you can find the right forex broker for your needs.
Each broker is going to have different offerings. As such, you need to keep in mind what features they have, and whether or not it fits with your trading goals. For instance, depending on the broker, some customers may have access to leverage, whereas others may have an easier time depositing and withdrawing funds. As stated earlier, some brokers may charge a certain percentage on the spread of a forex pair, or they may take commissions instead. As always, it pays to know how a broker makes itsrevenue and what their policies are before getting into forex trading.
Currency pairs offered
There may be a wide range of currency pairs available for trading, but there are a select few that are extremely popular, and therefore the most liquid. These include e the EUR/USD and GBP/USD pairs, as well as the USD/JPY and USD/CHF. Obviously, you will want to pick the broker that offers the currency pairs that you are interested in trading with.
As forex can be traded 24 hours a day, customer service and support should be available almost any time. This is especially important if you are new to forex trading or are new to the platform. If you are not sure what their customer service is like having a quick call with a broker can give you a good idea ofwhether you two can work together well.