How to Pay Your Forex Broker

Most people understand the way that commissions work when you are buying or selling shares. After all, firms like Scottrade and Etrade spend their advertising dollars boasting how low their commissions are at around $7 per trade. But when you come to trading Forex online, it is not so clear how your dealer gets paid.

Cost-free trading sounds like a good deal, but of course the Forex broker is recompensed in some way, and it can be worthwhile researching the different ways that you can deal Forex to see what works out the cheapest for you.

Typically, when you deal in stocks and shares you use a stockbroker, who goes to the exchange on your behalf to try and execute the transaction, and charges a commission for doing so. The Forex broker is more commonly actually a dealer, as he does not take a commission but acts as a principal in the transaction, taking on the market risk. The distinction is blurred, as some stockbrokers will also not immediately place orders on the exchange but fulfill them from their own stock, essentially taking on the risk of a market move. The market risk that the Forex dealer takes on is covered by his quoting a different rate of exchange depending which way you want to place the transaction. The difference between the two prices is called the spread.

That is in principle what happens, but the details can vary. In the simplest form of Forex fees, the spread is a fixed amount, a certain number of pips, and you know exactly where you are any time you choose to trade. You might see for instance that the GBP/USD was quoted at 1.5336 – 1.5338. It simply means that a pound sterling buys you $1.5336, but that you need $1.5338 to buy £1 – so if you bought US dollars and straight away sold them back, you would be out of pocket. Of course you would, as the dealer has done some work for you, and deserves to be paid for it. When the prices change from this level they will move together, with a spread of two pips. This is called a fixed spread, and at first glance it seems that this is the best way to trade.

But you can also find dealers who offer a variable spread. If there is a lot of trading going on, the spread might drop to only one pip, and when the markets are quiet it could go up to three pips, say, reflecting what the dealer feels he needs to cover his risk and his work. Depending on a number of factors, including when you trade and the currency pairs that you deal in, it can work out cheaper to trade with a variable spread. The only drawback is that you will find that hard to figure out until you actively trade with them.

These aren't the only ways you can be charged. You may also find a broker who makes a small additional charge, a commission, of perhaps a fraction of a pip, on each transaction. In return, you may find that this broker will consistently quote you tighter spreads, which will save you money there, or perhaps they have a custom trading platform which you prefer.

The effect of some of these things is not easy to pin down. Sometimes you just have to make a choice and see how it works out. But you should remember that there is a lot more to selecting a Forex broker than simply how much you pay him, and take all the factors into account when deciding where to trade.

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