What or who is a broker?
The word “broker” can have several meanings. I often get the question: You’re a broker, right? and the answer is: no, we make software that helps us and other investors in our trading activity. I don’t know how conclusive this answer is but it is certain that a broker has to intermediate a business or a relation between 2 or more parts.
The word “broker” may be used as:
– The person who offers you a service, general insurance services – the insurance broker
– The company that offers its clients the opportunity to invest in the capital or financial markets
– The person who works at a brokerage company (as the one above) and manages your money or takes your buy/sell orders and places them in the market
– The company/person who intermediates various businesses/exchanges
– … and many other meanings that I probably haven’t heard of.
Here, we talk about investments in the capital and financial markets in an environment in which, as a general rule, the final client invests his own money, making his / her own decision to buy/sell. For this reason, when we talk about a broker, we refer to a company that offers its clients the possibility to trade various shares, currency pairs, commodities, etc.
The broker has a website where they present all their services and products, has one or more trading platforms that they can offer to the client and, usually, offer several deposits and withdrawal methods.
How do you get to trade with a broker:
1. Create a trading account.
This procedure involves filling in an online form with your personal data and submitting documents attesting your identity and residence.
2. Deposit trading funds.
After you have the account approved in the first phase, you must send money to the brokerage company using the methods provided by that broker. You can usually deposit by card, bank transfer or other e-money services. The sent money will be credited to your trading account and this is NO lost money – these funds will allow you to actually make trades, that is to buy and sell.
3. The broker offers you a trading platform through which you can have permanent access to their products and you can trade within the available money.
The trading platform is an online or desktop application that you log in with a username and password.
How are the brokers making their money
I remember being in this field for over a year and I didn’t understand exactly what the brokers’ business model is … that is how they make money. It’s a pretty taboo subject and in time I understood why.
The brokers we speak of, those through which you can trade currencies, indices, commodities, act as the counterparty in the relationship with its clients. That is, if you buy EUR 10,000 on the EUR / USD currency pair, this means that the Broker will sell you that position.
If the EUR/USD ratio increases you will have a profit and if it goes down you will have a loss. The broker permanently offers you a purchase price and a sale price for any product you want to trade; exactly like a traditional currency exchange house: there is a purchase price and a sale price. There is no possibility to trade directly with another customer. You will always buy from the broker and sell to the broker (or to a supplier of his).
There are 2 main business models for Brokers:
1. A Book Model
The broker has one or more liquidity providers that offer the necessary liquidity for the trades of his clients. Think of a liquidity provider as a whole-seller and the broker would be the retailer. The broker will constantly adjust the quotes, displaying a purchase (bid) price and an offer (ask) price for any instrument, at any given time. When a client buys a position of 10,000 EUR on EUR/USD instrument, the broker knows that he can immediately re-purchase that same amount for a lower price from its liquidity provider. In this case, the broker earns the small difference between the price at which he bought from his liquidity provider and the price at which he sold to its client. Using this same business model, the A book, the broker can offer to its client the same price as they are getting from its liquidity provider but charging a commission for each trade the client makes, based on the trading volume. If the customer will have a profit in a position he will be able to sell at a higher price than the price at which he initially bought. At that time the broker will replicate the same trade with the liquidity provider and thus the broker will be able to give the profit to the client. So, using the A Book model, the broker earns money from commissions or mark-ups (those small differences between their buying price and their offered price for its clients).
2. B Book Model
The broker has one or more liquidity providers but they are used only to display updated prices to final customers. In this case, if a customer enters into a trade, the broker no longer replicates that trade with the liquidity provider. If the client will make a profit on that trade, the broker will have to pay that profit out of his own pocket. But if the client makes a loss on that trade, then the broker will earn the amount lost by the client. The statistics show that most customers lose money and that is why, for Brokers, it is very tempting to use this model.
What you need to do
Let’s recap: so, there are brokers who make money if you lose and lose if you win and brokers who earn a commission for every trade you make, without being interested in whether you win or lose.
Elementary logic tells us that brokers using the B Book model are in conflict of interest with their clients. However, there are brokers which use this model and have a fair practice towards its clients. Unfortunately, it is very difficult to know if a broker is A Book or B Book because many adopt a hybrid model, in which they mix the two models.
If you want to protect yourself from unfair Bokres you can follow the following steps, regardless of the brokers’ business model:
1. Read reviews about the brokers. It is best to read people’s opinions and not the texts written in the broker’s presentation by the review site. You can search for recommendations on these sites: Forexpeacearmy, Forexfraud, Forexbrokerz, FXEmpire.
2. Start with a demo account where you can see and test their platforms, their customer support services, etc.
3. When you start trading with real money, you would better initially deposit a small amount so you don’t risk too much.
In recent years we have witnessed an explosion of retail brokers and this is exciting because it is very easily accessible and there is a very varied offer due to the countless brokers out there. Finally, it is up to you to research and to make the best choice for you.
If you liked this article, we recommend you to check “Trading. The Good, The Bad and The Evil”