Understanding How the Forex Brokers Make Profits
When you open a currency trading account, you are told by your forex broker that there are no commissions involved in forex trading. New traders take their brokers word as true. Most think that the cost of trading is minimal.
Forex brokers also called FCMs (Futures Commission Merchants) make profits through the bid-ask spread they offer to their clients for each currency pair. This bid-ask spread is the trading cost for you and the profit for your FCM.
Lets take a practical example to make it clear how trading costs can effect your trading. Bid/offer spreads are usually overlooked by retail traders as the price they have to pay for trading. So lets calculate what your cost of trading can be annually.
Suppose you are day trading. 5 times every day, taking away the weekends, when you cant trade, there are 250 trading days for you.
As a day trader, you will open and close your position before the end of each trading day. That means each position is traded 2 times by you.
Suppose; your start with a deposit of $50,000. You use a leverage of 4 only, you are being cautious. So this $50,000 deposit will control (50,000) (4) = $200,000.
Annual Turnover = (5) (250) (2) (200,000) = $500 Million. You can see the annual turnover of your trading is huge! Now lets calculate how much your broker will make and what your trading cost is based on your spread cost. Spread Cost= (Annual Turnover) (spread)/2.
Suppose further, the bid/ask spread offered by the broker is 3 pips. 3 Pips Spread Cost= (500M) (0.0003)/2= $75,000.
Suppose the bid/offer spread charged by the broker is only 2 pips. 2 Pips Spread Cost= (500M) (0.0002)/2= $50,000.
The cost of trading with a 3 pips spread versus a 2 pips is $25,000. This is 50% of your account equity. You can see yourself that a 1 pip difference can result in $25,000 more of trading costs.
You will need to make a profit of $75,000 simply to break even with a 3 pips spread. Trading costs are one of the primary reasons most active traders fail in the long run. - 23218
Forex brokers also called FCMs (Futures Commission Merchants) make profits through the bid-ask spread they offer to their clients for each currency pair. This bid-ask spread is the trading cost for you and the profit for your FCM.
Lets take a practical example to make it clear how trading costs can effect your trading. Bid/offer spreads are usually overlooked by retail traders as the price they have to pay for trading. So lets calculate what your cost of trading can be annually.
Suppose you are day trading. 5 times every day, taking away the weekends, when you cant trade, there are 250 trading days for you.
As a day trader, you will open and close your position before the end of each trading day. That means each position is traded 2 times by you.
Suppose; your start with a deposit of $50,000. You use a leverage of 4 only, you are being cautious. So this $50,000 deposit will control (50,000) (4) = $200,000.
Annual Turnover = (5) (250) (2) (200,000) = $500 Million. You can see the annual turnover of your trading is huge! Now lets calculate how much your broker will make and what your trading cost is based on your spread cost. Spread Cost= (Annual Turnover) (spread)/2.
Suppose further, the bid/ask spread offered by the broker is 3 pips. 3 Pips Spread Cost= (500M) (0.0003)/2= $75,000.
Suppose the bid/offer spread charged by the broker is only 2 pips. 2 Pips Spread Cost= (500M) (0.0002)/2= $50,000.
The cost of trading with a 3 pips spread versus a 2 pips is $25,000. This is 50% of your account equity. You can see yourself that a 1 pip difference can result in $25,000 more of trading costs.
You will need to make a profit of $75,000 simply to break even with a 3 pips spread. Trading costs are one of the primary reasons most active traders fail in the long run. - 23218
About the Author:
Mr. Ahmad Hassam has done Masters from Harvard University. He is interested in day trading and swing trading stocks and currencies. Learn Forex Nitty Gritty. Read about Trend Forex System. Try Netpicks Forex Signal Service.
posted by X - Men @ 5:53 AM
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