Understanding Your Forex Broker’s Spreads and Fees

June 14, 2009 by  
Filed under Forex Trading

If you’re a beginner investor, there is a lot you should learn before becoming involved in the Forex market. You may have heard or read somewhere that Forex brokers don’t charge a commission, and this bit of information has you interested in switching your investment vehicles after paying hefty sums to your portfolio manager. This isn’t the entire story, however. There are still fees which need to be paid in the world of Forex – especially to the person making a living performing your trades for you!

Instead of charging a commission with each trade, Forex brokers will charge what is called a ‘spread’, which is exclusive to trades performed on the currency exchange rate market.

Market makers are the individual or company who is offering a currency pair for trade, and a broker acts as the middle man between them and you. Bid prices are what the market maker is offering the currency at, and the ask price is what your broker will sell it to you for.

This difference is how Forex brokers make a living. Now, let’s discuss other costs you may incur while engaging in Forex trades.

When you place an order to buy a currency pair, for example the euro/dollar, you are essentially buying euros, assuming they will be worth more in dollars with time (usually a very short amount of time). Most of these transactions are performed in lots of 100,000, which would require you to buy 100,000 euros – not very affordable to most, and even laughable by seasoned veterans.

Your brokerage firm has another option that can solve this dilemma. They will leverage your buy at a 100:1 ratio, where you front 1% of the price and they will ‘loan’ the other 99%. This allows you to actually invest a very small amount of money and can still reap large rewards if you buy and sell at the correct times.

However, this means that if you don’t time your sell just right, or if you buy too high, you will most likely lose your entire personal investment, as well as owe your Forex broker their share of the loss. This is why practicing and starting small is so important!

You should feel like you can explain Forex trading to someone that knows nothing about it prior to entering the practice of buying and selling there. This market is far more volatile and requires quick decisions and a broker you can trust before benefiting from the activity.

Movements of only a few pips can translate to extremely large sums of money when you’re talking about a 100k account. One pip means the exchange rate changes only by a ten-thousandth of a point. This seems quite small until you multiply that by 100,000!

To reduce your risk and make you more comfortable, perhaps you should inquire about or find a Forex broker who offers a mini account. Of course, small changes will affect this account more, but you risk losing and owing less, too.

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