Many people might wonder how brokers actually get paid in financial markets. Since I started this channel, I’ve received tons of questions about brokers, their commissions, and how much it actually costs, in the end, to use algorithmic trading software to gain an edge in your portfolio. Today, I want to go over the different ways that brokers get paid through your trading accounts. Without further ado, let’s dive right in.
Welcome! If you’re new to the channel, my name is Matt Jimenez. I’m an entrepreneur who has worked with some of the greatest minds in finance over the last several years. I’m here to share with you everything they taught me. Today, we’re going to stick to the topic of brokers. I’ve been on a little tangent lately with brokers, considering all the interest around brokers in the trading industry, especially since I’ve been documenting the algorithmic trading software on my brokerage account. People often see the commissions and other details as I go over the results, so I figured I should make a video explaining how brokers actually get paid.
If you haven’t seen my last video on the different types of brokers and what to look for in brokers, hit the link above. In this video, we’re going to focus on the different types of incentives brokers have for you to start an account, especially those with trading software that are very active. I’m going to go over a list of four ways brokers get paid. None of them are in any specific order; this is just a list.
The first way brokers get paid is through the spread. If you don’t know what the spread is, it is essentially the difference between the market price and the price that the clients are actually getting. Remember, the broker is the intermediary between the market and you to fulfill your order. Each time you place an order, the broker makes money by creating a difference called the spread. This difference is between the price you get and the actual market price. The broker will mark up this difference and set the spread.
Typically, in the foreign exchange market, spreads vary from 1 to 20. The way to gauge it is simple: the lower the number, the better. So, when you hear about tight spreads, it means the broker has a lower spread number. One thing to keep in mind about spreads is that they are always changing. Depending on the times you are trading or when your algorithm is trading, the spread will vary from high to low. Tighter spreads are preferable because it means you won’t spend as much to facilitate trades.
However, if you’re using a trading algorithm, you don’t have to worry much about that. Even if you’re trading manually, the moment you enter a trade, the spread is immediately paid. This is why your trade is automatically negative when you start; it’s not because you took the wrong trade but because you have to pay the spread upfront.
The valuation of the spread will vary depending on your lot size. For example, if you took a trade with a 1.0 position size, which is one standard lot, it means essentially $10 for every market fluctuation. Let’s say the spread is five, so you have a standard lot size of one and the spread is five, you are spending $50 just to enter that trade. In order for you to become positive, you actually need the trade to go in your favor by at least six pips because five pips are covering the initial cost of taking that trade. That extra pip is for your pocket.
Now, the next way that brokers get paid is through commissions. While this may seem very similar to the spread—because it kind of is—it is a tad bit different. Here’s the difference: the commission is a fixed cost, while the spread is a varying cost. Commissions are executed on your behalf the moment you take a trade without you having to actually pay them out of pocket. People often get confused, wondering who they are paying these commissions to and how they pay them. You don’t. The moment you take a trade, the commission is automatically sent to the broker and is paid upfront. This is different from the spread because the commission is a fixed cost.
Some brokers offer the incentive of no commissions, which is obviously the most attractive option. Typically, brokers that offer no commissions tend to have a higher spread to make up for the difference. Some brokers provide tight spreads and lower commissions, or different variants of both. Nonetheless, you need to assess what you think is appropriate for your trading portfolio. I myself don’t mind commissions and typically always look for tighter spreads because it just makes more sense. I’m not going to give any recommendations on brokers because that’s not my realm. I’m just here to give you knowledge on brokers so you can make an informed decision on which broker to go with.
Now, the third way brokers get paid is through rollover fees. You’ve probably heard the term swap fees. Essentially, a swap fee is your broker charging you interest to hold your position overnight or over a week, depending on your broker. As I said, every broker is different, and if you haven’t seen the video I did on brokers, you should watch it because it illustrates how different brokers operate, and it’s important to know that.
Swap fees and rollover fees are very common, especially when you’re holding positions overnight, over a week, or even longer. However, this is not something you need to worry about if you are using a high-frequency trading mechanism or if your strategy is more of a scalping-based strategy, meaning you’re in and out of positions pretty quickly. In that case, you’re not holding positions overnight, so you’re not charged interest. This is more relevant for swing traders or those using an algorithm that is long-term, meaning it holds positions for weeks or months on end. Obviously, the interest will accumulate, but then again, the interest is usually not that much. Of course, the longer you hold, the more you pay, but as I said, it’s very minuscule in comparison to the position you’re holding.
I may say it’s minuscule, but depending on your position size or how long you’re holding the trade, it could add up. I’d be lying if I said it couldn’t. However, this is not something that I really worry about because with the algorithm that I’m using, which is pretty high-frequency, the longest trade I can remember off the top of my head is probably about a week long, and the interest is actually negligible in my eyes. Also, keep in mind that sometimes swap fees can go in your favor, which I’ve seen, and that is dependent on exchange rates changing overnight. But we’re not going to get into that now; we’re sticking to exactly the way brokers get paid.
Now, the last thing I’d like to address on how brokers get paid is through fees. Yes, I know that you’re thinking, “Matt, you just said ‘fees’ three times.” I know, everything sounds like a fee, and unfortunately, everything is a fee. Watching this video is a “fee” of your time, but in exchange, you’re getting information.
The way fees typically work in brokerages is that they charge you on initial deposits or any deposits, and then sometimes they’ll charge you on withdrawals. When you’re auditing a broker and deciding which ones you want to work with, make sure that the fees for moving money in and out of their custodial service and their execution service are minimal or none. This is important if you don’t want to pay too much in fees because you’re already potentially paying spreads, commissions, rollover fees, and then possibly deposit and withdrawal fees.
So, those are the four ways that brokers get paid, and this is very important to note when you’re looking to work with a broker. Remember, they’re holding your money, so you want to make sure that you do a deep dive on any broker that you work with because they are actually the largest counterparty risk to all of trading, essentially. They are the ones holding all of our retail investor money.
One thing I also want to mention is that brokers who typically charge a fixed commission or higher fees sometimes tend to be the more legitimate ones. They have to pay for operational costs, meaning they probably have a staff, different departments to run, a legal team, etc. It’s important that we, as retail traders and investors, can pay for those fees so they can operate and help us. We’re here to make money in the markets, and they are the vehicle to do so for us.
So, take that into account. Every business needs to make money and every entity has operational costs, so don’t be such a stickler when it comes to that. Business is business, and you should be willing and happy to do business with people who operate with morals and ethics.
If you’re interested in using an algorithm that you can attach to the brokerage that you choose, hit the link in the description below. If you want to skip all the fluff and already know a bit about us, go to the comment I pinned below. If you hit that link, you can book a call with the team and see if this is the right fit for you.
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As always, my friends, peace.
Please visit How Forex Brokers Get Paid to watch the full video on YouTube!
