Understanding How the Forex Brokers Make Profits

When you start currency trading, you are told by every forex broker that there are no commissions involved in forex trading. New traders take their brokers words as true and most think that the cost of trading is minimal.

Forex brokers are also known as FCMs (Futures Commission Merchants). They make profits through the bid/ask spread they charge their clients for each currency pairs. This bid/ask spread is your trading cost and profit for your broker.

Lets do a simple calculation. Spreads are usually overlooked by the individual traders as the price they pay for trading. So lets calculate your cost of trading.

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.

Your Annual Turnover will be; (5) (250)(2)(200,000)= $500 M. Huge! Now lets calculate how much your broker will make and what your spread cost is. Spread Cost= (Annual Turnover) (spread)/2.

Suppose further, the bid/offer spread charged by the broker is 3 pips. 3 Pips Spread Cost= (500M) (0.0003)/2= $75,000.

Suppose, the spread offered by the broker is only 2 pips. 2 Pip Spread Cost= (500M) (0.0002)/2= $50,000.

You can see yourself, the cost of trading with a 3 pips spread versus a 2 pips is $25,000. This is 50% of your account equity. You see, a 1 pip difference can result in $25,000 more as trading cost for you.

You will have to make a profit of $75,000 simply to break even. Trading costs are one of the reasons most active traders fail in the long run.