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How Do The Brokers Make Money?

12
Jun 2016

In any investing opportunity, it’s smart to have professional help if you don’t happen to be a financial professional in your own right.  Paying a broker to help you navigate the tricky waters of financial investing can earn you more money in the long run, even despite the increase in start-up costs.

When investing in securities and stocks, brokers typically send customer orders through independent exchanges and charge commission to the customer for each trade executed, regardless of whether the stock makes, or loses, money.  In contrast, foreign exchange brokers handle executing the customer orders themselves because there are no centralized currency exchanges.  The value of the exchange is set by the country that owns each currency.  Not having to deal with a central exchange allows the brokers to make money in two ways:

  • Brokers try to buy low, and sell high, whenever possible, as any investor would. However, the Forex brokers make money off of the difference between the purchase, and sale price of the currency, while stock brokers make a commission off of the purchase of the stock, and those commission rates are set prior to the purchase.  Forex brokers can set their rates at whatever proportion of the spread that they choose.
High school students using Khan Academy
High school students using Khan Academy
  • Brokers also earn money off of a portion of the spread associated with your currency exchange. The spread is the difference between the bid price for a trade, and the actual price.  The bid price is what you, the investor, would receive, and the ask price is what you’ll have to pay.  The difference between the two is the amount the broker bases his or her fee on.  The spread can also be a fixed or variable rate, and it is important to know which, before you make an investment.  A change in interest rates or other market event could either help you or hurt you depending on which way the change affects the value of your investment.  A decrease in the spread could result in fewer profits to you, because your broker’s commission percentage would be fixed, while the spread might not be.  Some brokers take fees on both the spread and on the sale, so make sure you know which your broker or brokerage agency takes, before you agree to open an account with them.

The difference between the two revenue streams is that one is paid to the broker, and earned by them, up front while the other is earned after you sell.

While going it alone might seem like the best way for you to maximize your own profits, and minimize brokerage fees, you still run the risk of losing more money than you make, due to inexperience with spotting market trends.  Keeping yourself informed regarding the commission and fee structure of any broker you choose to work with will prevent any surprises when it comes to purchasing or selling your currency investments, and will also guarantee that you have the professional help you’ll need to make sound investment decisions.


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Benefits for Forex Investing Versus Securities Investing

12
Apr 2016

In addition to having fewer barriers to entry than the stock market does (minimum stock purchase requirements, high levels of capital available for startup, high brokerage fees, and vast amounts of stocks to research before investing), Forex investing allows investors to benefit from the misfortune of their own, or other, national economies.  While that might sound like a rather gloomy prospect, it actually just allows investors to spot economic trends, and take advantage of the opportunity to make a little money off of the strength or weakness of another currency through timely purchases or sales.

If, for example, you live in Australia, and the economy starts to decline, you can bet against the AUD and purchase a currency that is expected to be valued at a higher rate than your own, before the AUD takes much more of a downturn.  The more the value of your own currency declines, the higher the likelihood of the value of your Forex investment to increase, thereby generating profits for you, regardless of the strength of your own nation’s economy.  Then as your own currency value increases again, you can decide whether or not to sell off the investment you made when the downturn began.

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Forex trading also allows for a nice diversification option for your investments, outside of the regular stock market options.  Plus, the Forex market is 30 times larger than both the NYSE and Nasdaq put together, it does more than $4 trillion USD in trades, and it is much more liquid than stock market investments.  Forex investments can be profitable both when selling short and betting on a declining value, as well as selling long by holding onto an investment and hoping for a value increase.  By comparison, investors often lose money by trading a stock or equity short because the markets are much more volatile, and also close each day, making it impossible to continue making money off of their money as soon as the markets close, and until they reopen.  Selling a stock the moment it starts to decline can save you greater losses on the one hand, but on the other can also be a knee-jerk reaction to a lull, when the stock’s value can increase again rapidly because of the number of factors that can affect the value of corporate stocks.  The Forex market runs 24/7, allowing investors to move their money or cash out at any hour of the day, and the value of currency is dependent on factors that affect the national economy.  Those types of factors are fewer, and more obvious, than those that affect corporate equities.

Another benefit is that unlike equities, which can be bought on a margin and leveraged, Forex transactions cannot be purchased on a margin.  In other words, a leveraged investment can end up costing you more money than you spent to acquire it, while currency purchases do not offer that same option, nor risk.  The amount of money you spend to make a currency investment is equal to the maximum amount of money you are at risk to lose.

Trading in currencies permits investors to diversify more easily internationally than securities and equity investments allow.  The reason being that looking into foreign companies to purchase stock from, and the health of foreign commodities markets, can be extremely difficult, especially to amateur investors.  The amount of research required, potential language barriers to conducting that research, and variable factors affecting the health of corporations in foreign markets, can make any sort of research difficult even with a broker’s help.  However, the health of a currency can be fairly easily determined, at the top-most level, by the health of the country and what general factors might be affecting a foreign economy.


Economic data table of currencies prices on computer screen

What Is Currency Trading? And Why Do It?

7
Apr 2016

There’s a saying that says the best way to make money is with money.  Outside of investing in the stock market to have your money work for you, another way to use your money to make money is through currency trading.  What that means, is that you can buy and sell currency on the foreign exchange, or “Forex”.  Quite simply, you buy money from the central bank of another country at one rate, and hold onto it until the rate changes, and then you sell it off.  You’re making money, by buying and selling money.

About $3.2 trilling USD (United States Dollars) is traded on Forex markets every day, and unlike stock markets, Forex markets are accessible 24 hours a day.  Other benefits of trading Forex include the fact that many brokerage firms do not charge commissions.  All you pay for are the bid asks and point spreads.  You can also focus your trading efforts because there are only so many currencies that are worth trading, whereas when trading equities you have thousands of options, which can sometimes be overwhelming to pour through and watch.  Plus, it’s relatively inexpensive to get started trading Forex because you are not required to put a lot of money up when you start.  In fact, one of the U.S.’s largest brokerage firms, FXCM, allows customers to start trading with as little as $50 down.

Currency trading is available through any avenue you might normally use to perform stock trades.  There are several online brokers, or you can work with a Forex broker at a financial institution or other major brokerage firm.  The way it works is that you purchase a trading pair (your currency for another) based on a derivative price.  That derivative is a contracted price to sell a currency, based on projected value, at a future date.  Often times these sales happen very quickly, which allows for a high degree of liquidity with this type of investment.  You can see the results of your investment very soon after you make it, and you can cash out your investment whenever you like (which is further helped by the Forex market hours being 24/7).  With traditional stocks, or other investments, the time it takes for you to see a real profit varies, and there are also waiting periods you have to endure when waiting to cash out an investment.

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The other benefit to investing in foreign currency is that it offers a nice diversification to your investment portfolio.  Never put all of your investing eggs in the same investing basket.  Having a wide variety of stocks, at multiple risk levels, and balancing things out with some foreign currency investments, is the best way to make sure that you’re making money off of some of your investments at all times, even if others aren’t performing perfectly.  Also, the information that affects the volatility of Forex markets is absolutely public, and is available in real-time.  While stock information is also public, it can be harder to find and harder to sift through, as the number of factors that affect corporate stocks are much more varied.  Plus, the wide availability of this information will allow you to better hedge your potential losses.  Knowing one currency is going to start declining in value due to socio-economic or political factors, allow you to sell it before you lose much of your investment, and instead redirect your funds to another purchase that will yield greater returns.

Currency trading can be a great way to earn money quickly, but it can also be a quick way to lose it.  While investing on your own has been made easier thanks to the multitude of online offerings now available, it’s best to work with a financial professional who can help you better spot market trends, and take advantage of the market that never sleeps.


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Tips for Getting Started with Forex

31
Mar 2016

If you are planning to expand your investment portfolio, or start it, with some foreign currency purchases, there are a few things you should master before you start.  Forex investing takes just as much homework as equity investments do, but you have a much smaller number of sources you’ll have to pull from to get the information you need, as you’re purchasing currency from other countries, not pouring through thousands of stocks in both domestic, and foreign, markets.

The first thing you should familiarize yourself with is the language of Forex investing.  Currency traders use a jargon typical to their trade, and if you’re going to participate, you should know how to translate what they’re saying.  There are several Forex glossaries available online, and if you are working with a broker, they likely have a glossary mixed in with the investing tools on their site.  Once you understand what the industry’s terms mean, your ability to understand how to best participate in Forex will improve as well.

The next thing you should do is figure out what your investment goals are, and how to achieve them.  This means, figure out how much you’re willing to lose, as well as what you would (realistically) like to make, and then start planning where to invest.  In order to invest wisely, most traders forecast currency performance based on currency charts.  The idea is that by plotting how certain markets have performed solely based on the currency itself, that future behavior can also be predicted.  Many traders supplement that with a fundamental analysis of what events have influenced foreign markets, and in what ways, with what frequencies.  Since the health of a country’s economy is largely based on political and socio-economic factors affecting the people within, all of those factors naturally can affect the strength of the currency.  All projections are built on some form of past performance analysis.  None is guaranteed, but this method will get you closer to making a sound investment, instead of a foolish one.

Blue Forex charts with green growing arrow and dollar coin
Blue Forex charts with green growing arrow and dollar coin

If you have the opportunity, you should also look into setting up a “practice” investment account.  Several large brokerage firms will offer these kinds of accounts for new traders for free, which is a good way for you to get familiar with how to conduct currency trades, as well as a good opportunity for the brokerage firm to familiarize you with their platform.

When working with a broker, you’ll also want to find out exactly how your orders are going to be processed, and what kind of commission structure, and valuation structure, they use.  Does your Forex broker use a dealing desk or not?  A dealing desk is a term for when your broker uses a fixed spread to create the pricing for your orders and execute them.  Also, are your currency pairs quoted to four decimal places or one base point?  A price-interest-point, or pip, is usually based off of valuing a currency to 4 decimal places, and refers to the difference between two currencies in a trade and is dependent upon not only the pair being traded, but also on the size of the trade, and the exchange rate.  Can you hedge your investments, allowing yourself to simultaneously buy and sell positions in the same currency pair?  And what kind of customer support does your broker offer?  Since the Forex market is available all day, every day, it’s helpful to know what kind of hours your broker keeps, as well.

Lastly, as you’ve been reminded before, never invest money in Forex transactions that you can’t afford to potentially lose.  Foreign exchange trading comes with a high adrenaline rush because it can be done so quickly, but it can also change quickly.  This kind of investment comes with a very high level of risk, which does not make it ideal for some people.  When in doubt, truthfully examine if this kind of investment will get you toward your financial goals successfully or not.  If you aren’t sure, work with a professional Forex broker to help you figure out what kind of Forex investment is right for you, if any.


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Tips for Improving Your Foreign Currency Investment Performance

22
Mar 2016

Once you have had the chance to set yourself up with a Forex broker or a Forex account of your own, and you have determined what you want to invest in, and how much, there are a few steps you can take to ensure that you are attaining the maximum amount of profits possible.  Even the most skilled traders can benefit from a trading skills update from time to time.  Here are a few suggestions for elements to brush up on:

  1. Come up with a plan, and write it down. Your plan should include choosing currency pairs that are right for your goals and your available funds to invest.  Some currency values change dramatically throughout the course of the day, others barely move and instead change in value over long time periods.  Evaluate how much money you are willing to risk, compare that to the volatility of the pairs you want to invest in, and make your investments accordingly.
Global Business
Global Business
  1. Plan how long you want to stay with each investment. Do you want to stay with them for a matter of hours?  Days?  Minutes or months?  Some plans do charge rollover charges if you hold on to them for long periods of time.  Make sure you know which brokerage plans have what options before you invest, and which funds you plan to sell quickly or hold on to, and for how long.
  2. Always plan your exit strategy. Have an idea of the thresholds you are comfortable with, both for losses, and potential profits, and stick to those limits.  Holding onto a currency pair after you have reached your profits threshold, especially if you’ve done your research and you know how high that currency is likely to go, could result in a popped profits bubble, and you could end up losing money anyway.
  3. Follow the market. Forex charts and market analysis tools and reports are readily available to help you plot currency trends and improve on your trading returns.  If you decide to purchase a financial charting package, you will quickly be able to make up the cost of the purchase through the profits you will make off of your improved trades.  There are also several market analysis tools that will provide insight into what the current market status is, projections on what direction it’s moving and why, and trading strategy tips from experienced Forex traders.
  4. Write it down. Keeping records of your investment decisions, the performance of your investments both before purchase, during, and after, can help you not only not repeat past mistakes (and every investor makes a few) but also spot trends in the funds you have purchased in the past.  When keeping your records, make sure that you note the rate you purchased the currency for, as well as sales rate, your strategy for the purchase and what your limits were, what your profits or losses were, and note whether or not you actually followed your strategy!  Knowing what you’ve done, and what has worked or not worked, will help you make better decisions later on.

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5. Learn to manage your risk. Be a disciplined trader, and make use of limits on orders whenever possible.

6. Pick an analysis approach before you start investing. Do you want to use technical analysis, which analyses historical data to make future performance predictions, or do you want to use a more fundamental analysis that uses more market data to analyze trends and focuses only on a few currency pairs at a time?

7. Know what the interest rates are for the central bank of the country whose currency you want to trade. Also know the unemployment rate, because that will be a good indication of the strength of that nation’s economy.  Keep an eye on geopolitical events that could affect a country’s need to spend, and therefore the availability of funds and the foreign exchange market.

8. Don’t get too attached to a trade, and set attainable limits. Forex trades are usually best when set at short-term limits.  Be ready to let a trade go when your limit is reached.  Also make sure that your expectations for an investment are realistic, and based on the research you have done.


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The Beginnings of Foreign Currency Exchange

12
Mar 2016

The foreign currency exchange market is considered to be the largest financial trading market in the world, with annual sales between $3.5 trillion USD, and $5 trillion USD, depending on whom you consult.  It is comprised of banks, national central banks, investment management firms, commercial companies, hedge funds, and retail forex brokers and investors.

Foreign currency exchange started in the 1970s as a service only available to banks and financial institutions.  Since the trading was only happening between banks, regulators permitted the currency swaps to happen directly between the institutions, rather than on a regulated exchange, which was standard for stocks, futures, and commodities.  In the 1990s smaller companies began opening up the trade options to amateur investment, but there was still no real regulatory monitoring.  With the advent of the internet, online trading exponentially expanded in a very short period of time.  Currency brokers were put under the Corporate Future Trading Commission’s purview in 2000, but that still hasn’t created the transparency in the currency exchange market that regulators had hoped it would.  That’s why brokers are still very helpful to investors to determine whether a currency price offered is a good deal or not.

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But even before Forex became what it is today, the origins of this kind of market can be traced back to the creation of the gold standard monetary system in 1875.  Just prior to the gold standard being established, countries would accept payments in gold or silver form each other.  The only issue with this was that the value of those precious metals was dependent on global supply and demand, and when a new mine would open up, the gold and silver values would decline.  The establishment of the gold standard set a guaranteed conversion rate for currency into a specific amount of gold.  Over time, the difference between what one country counted as the price for an ounce of gold, and how another valued it, became the exchange rate.

The gold standard broke down in the beginning of World War I due to the tensions between European countries and Germany, so the major European powers began to print more money to help pay for military projects.  The high costs for those projects exceeded the amount of gold that the countries had on hand to exchange for other currencies.  Following World War II, the Allied nations set up a system dubbed the Bretton Woods system of monetary management in order to fill the void that was left by the abandoned gold standard.  That new system developed a method for fixing exchange rates, set the U.S. dollar as the primary reserve currency against which the value of all other currencies would be set, and the system created three distinct international agencies to oversee economic activity – the International Monetary Fund (IMF), the General Agreement on Tariffs and Trade (GATT) and the International Bank for Reconstruction and Development.

While the Bretton Woods system only lasted until 1971, when President Nixon closed gold trading, the 3 regulatory agencies remained, as did the setting of international currencies against the U.S. dollar.  From the 1970s forward, the ability to exchange international currencies and make a potential profit off of the timely buying and selling of foreign currencies, became available to financial institutions, as they were backing the currency exchanges from the start.  But it was not until the 1990s that individuals began to be allowed to take advantage of this kind of investment opportunity as well.