Forex Broker: Definition, Role, Regulation, and Compensation.
Gordon Scott has been an active investor and technical analyst of securities, futures, forex, and penny stocks for 20+ years. He is a member of the Investopedia Financial Review Board and the co-author of Investing to Win. Gordon is a Chartered Market Technician (CMT). He is also a member of CMT Association.
Updated November 15, 2021.
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What Is a Forex Broker?
A forex broker is a financial services company that provides traders access to a platform for buying and selling foreign currencies.
Forex is short for foreign exchange. Transactions in the forex market are always between a pair of two different currencies.
A forex broker may also known be as a retail forex broker or a currency trading broker.
Understanding the Forex Broker.
The foreign exchange market is by necessity a global and 24-hour market.
The clients of a forex broker include retail currency traders who use these platforms for speculation on the direction of currencies. Their clients also include large financial services firms that trade on behalf of investment banks and other customers.
Any individual forex broker firm will handle only a small portion of the volume of the overall foreign exchange market.
Key Takeaways.
Forex, or foreign exchange, trading is primarily between pairs of currencies of the nations that are represented in the G10. The clients of forex traders are currency speculators or investors for large institutional clients. Interested investors have a number of choices among forex traders online.
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The Role of a Forex Broker.
Most foreign exchange transactions are between pairs of the currencies of the 10 nations that make up the G10. The nations and their currencies include the U.S. dollar (USD), the Euro (EUR), the pound sterling (GBP), the Japanese yen (JPY), the Australian dollar (AUD), the New Zealand dollar (NZD), the Canadian dollar (CAD), and the Swiss franc (CHF).
Most brokers allow customers to trade in other currencies, including those of emerging markets.
Using a forex broker, a trader opens a trade by buying a currency pair and closes the trade by selling the same pair. For example, a trader who wants to exchange euros for U.S. dollars buys the EUR/USD pair. This amounts to buying euros using U.S. dollars.
To close the trade, the trader sells the pair, which is equivalent to buying U.S. dollars with euros.
If the exchange rate is higher when the trader closes the trade, the trader makes a profit. If not, the trader takes a loss.
Opening a Forex Account.
Opening a forex trading account these days is quite simple and can be done online. Before trading, the forex broker will require a customer to deposit money into the new account as collateral.
Brokers also provide leverage to customers so they can trade larger amounts than they have on deposit. Depending on the country the trader is trading from, that leverage can be 30 to 400 times the amount available in the trading account.
High leverage makes forex trading very risky and most traders lose money attempting it.
How Forex Brokers Make Money.
Forex brokers are compensated two ways. The first is through the bid-ask spread of a currency pair.
For example, when the Euro-U.S. Dollar pair is priced as 1.20010 bid and 1.20022 ask, the spread between these two prices is .00012, known as 1.2 pips. When a retail client opens a position at the ask price and later closes it at the bid price, the forex broker will collect that spread amount.
Secondly, some brokers charge additional fees. Some charge a fee per transaction or a monthly fee for access to a particular software interface or fees for access to special trading products such as exotic options.
The forex industry is regulated by the Commodity Futures Trading Commission and the National Futures Association.
Competition among forex brokers is currently intense and most firms find they must eliminate as many fees as possible in order to attract retail customers. Many now offer free or very small trading fees beyond the spread.
Some forex brokers also make money through their own trading operations. This can be problematic if their trading creates a conflict of interest with their customers. Regulation has curtailed this practice.
Regulation of Forex Brokers.
The industry is regulated by the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA).
Anyone considering opening a forex account can research the available brokers through the NFA website or through Investopedia's broker reviews.