What it means
There is no central currency exchange, so almost everyone below the largest banks reaches the market through an intermediary. The broker aggregates prices from banks and other liquidity providers and shows the client a single quote to trade on.
Two pricing models dominate. A dealing desk or market maker broker takes the other side of the client's trade and earns a wider spread, while an agency broker passes orders straight to liquidity providers, quotes a tighter raw spread and charges an explicit commission instead.
Regulation is the main thing that separates a safe broker from a dangerous one. Reputable jurisdictions require segregated client accounts, minimum capital, negative balance protection and limits on leverage, while lightly regulated offshore entities may offer none of these.
Cost comparison is harder than it looks, because the headline spread is only one component. A trader has to add commission per lot, the overnight swap charged or paid for holding a position past the daily rollover, and any slippage between the quoted price and the filled price.
For companies the equivalent question is which bank or payments provider to use for currency conversion, and the same logic applies. A quoted rate that looks close to the market can still contain a hidden margin, so it pays to compare the all-in rate rather than the advertised spread.
In practice
Real-world examples.
Example
A retail trader compares two brokers, one quoting a 1.4 pip spread with no commission and one quoting 0.2 pips plus $7 per lot round turn. On a single standard lot the first costs 1.4 x $10 = $14 and the second costs 0.2 x $10 + $7 = $9, so the commission-based account is cheaper.
Example
A small import business uses a regulated currency broker rather than its bank for a $400,000 supplier payment. The broker's all-in margin is 0.25% against the bank's 1.1%, saving $400,000 x 0.85% = $3,400 on that single transfer.
Example
A fund manager rejects an offshore broker offering 500 to 1 leverage after finding that it holds client money in the same account as its own. She opens instead with a firm in a well-regulated jurisdiction that caps leverage at 30 to 1 and segregates client funds.
Formula
Calculation
Total cost of a trade = Spread cost + Commission + Overnight swap
Spread cost = Spread in pips x Pip value per lot x Number of lots
A trader buys 2 standard lots of the euro against the dollar. One standard lot is 100,000 units and one pip is worth $10 per standard lot, so a 2 lot position moves $20 per pip.
Spread cost at 0.8 pips = 0.8 x $10 x 2 = $16. Commission of $3.50 per lot per side gives $3.50 x 2 lots x 2 sides = $14. The position is held over two nights at a swap charge of $2.50 per lot per night, so $2.50 x 2 x 2 = $10.
Total cost = $16 + $14 + $10 = $40.
If the price then moves 25 pips in the trader's favour, gross profit is 25 x $20 = $500 and net profit is $500 - $40 = $460. The broker's charges therefore consumed $40 / $500 = 8% of the gross gain.Case study
Seen in the real world.
Vantry Freight is a fictional logistics company used here as an illustrative example. It converted about $9,000,000 a year into three currencies to pay overseas hauliers, and its finance manager had always used the company's main bank without ever asking what the conversion actually cost.
A short audit compared the bank's applied rates against the mid-market rate at the same timestamps and found an average margin of 0.9%, or $9,000,000 x 0.9% = $81,000 a year. Two regulated currency brokers quoted 0.3% and 0.35% for the same volumes, and Vantry moved the business to the cheaper one, budgeting a saving of $81,000 - $27,000 = $54,000 a year.
The finance manager kept the bank relationship for credit lines and split payments across both providers so neither became a single point of failure. She also added the all-in margin to her monthly reporting pack, which made the cost visible to the board for the first time.
Watch out
Common mistakes.
- Choosing a broker on advertised spread alone, ignoring commission, overnight swaps and slippage that often make the cheap-looking account dearer.
- Treating high leverage as a benefit, when 500 to 1 leverage mostly increases the speed at which an account can be wiped out.
- Assuming client money is automatically protected, when segregation and negative balance protection depend entirely on the broker's regulator.
Questions
People also ask.
How does a forex broker actually make money?
Mainly from the spread between its buy and sell prices, plus commission per lot and the overnight financing charged on positions held past the daily rollover.
What is the difference between a market maker and an agency broker?
A market maker takes the other side of client trades and earns a wider spread, while an agency broker routes orders to outside liquidity providers and charges a visible commission on a tighter spread.
Does a business need a forex broker to pay overseas suppliers?
Not necessarily, but a specialist currency provider usually quotes a smaller margin than a high street bank, which matters once annual conversion volumes reach seven figures.
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