Many people are investigating the potential of CFDs as a way to earn money. One of the best advantages of Forex trading is that it allows you to avoid the high commission fees charged by agents who work with traditional stocks and commodities. However, most investors will still need the services of a reputable broker who can supply a connection with the liquidity providers who offer currency pair pricing. Traders are often curious about how these brokers profit from the order process.
First, let’s review how currency pair orders are created. Investors choose two currencies, and then decide which one of the two is most likely to go up, and which one is likely to go down. To open a trade, the investor buys lots (generally between 1,000 and 100,000 units) of the currency that he believes will be more successful.
To close the trade, the investor must eventually sell the same number of lots of that currency. However, when a trade is opened there is always a difference between the buy price of a currency and its selling price. That difference is called “the spread”.
The spread exists because the selling price of a currency at any given time is usually lower than the buying price. This means that you need to have the currency move more than that difference before you see any profits from that order. The most common way for brokers to make money is through the spread.
There are two main types of trading models that brokers choose: straight-through processing and the dealing desk. Let’s look at how both options can affect traders.
With straight-through processing (STP), the brokerage simply finds currency pairs to buy and sell, and gives the rates that they find to the trader. They charge a small fee for the service of finding prices. On the other hand, dealing desk brokers, or market makers, match buyers and sellers, or function as a seller directly.
Dealing desk brokers typically earn a small amount from each client that they match, and the can also make money from the spread.
While it may seem that STP trading would lead to lower spreads, the broker needs to make money somehow. This can sometimes mean that liquidity providers with higher prices might pay them a bonus to bump up their ranking. This type of company also does not offer flexibility during periods of high volatility.
This can weaken risk management strategies such as stop/loss orders, which rely on a set price being available in order to go into effect. Traders have suffered large losses when STP brokers have been unable to provide necessary liquidity.
On the contrary, market makers can use low spreads as a way to entice more buyers into the market, which they can use to match against their existing pool of sellers, in the hopes that they will make more money overall from a higher trading volume.
With this type of model, it is much easier for a trader to find currency pairs at whatever price they desire. Currency pairs are one of the best ways to profit from the relative performance of global economies.