Any trader who has opened a live forex trading account for even a short period of time has probably asked themselves how forex brokers earn their money. This is a common question for those new to FX trading, which is why we wish to explore the subject in greater detail.
2 Main Avenues of Revenue for FX Brokers: DD & STP
There are basically 2 ways in which forex brokers generate revenue. We’ll briefly outline them and then dive into specifics. The first method is known as STP or straight through processing. With this approach the broker earns a certain dollar value per trade. The revenue model is rather simple: the greater the number of trades, the more revenue earned.
The second method is often referred to as a dealing desk (DD) model or market making. In this model the broker assumes the full risk of each trader received. In other words, if a trader buys EUR/USD in the trading platform, then the broker in effect is selling EUR/USD to them. To better understand, just imagine the mirror image of any trade you’ve ever placed with the potential loss or profit being on the book of the broker rather than yourself. In other words, the future movement of the currency pair determines the profit or loss for the broker.
How Forex Brokers Make Money with the STP Model?
STP stands for Straight Through Processing, which is just a fancy way of describing the flow of an order between a trader and broker. In this model, when a trader opens an order, ie buy EUR/USD then the broker also buys EUR/USD in their trading account, tacking on either a commission or spread mark up. The order in our example is sent to one of the liquidity providers the broker works with, meaning that no financial risk is undertaken with this business model.
As previously mentioned, brokers operating under the STP or NDD (No Dealing Desk) model must rely on client volume to earn revenue, the more volume, the more revenue. Many traders perceive this model as advantageous since the interest of the broker is aligned with the client.
The Dealing Desk Model: How do Brokers Earn from a Dealing Desk Set Up?
As already outlined, the dealing desk model involves a broker assuming the full risk of an order. With such a model the broker can earn from the losses of a client, although such an explanation is far too simple. Generally speaking a broker has more than 1 client so performs the same market analysis traders do. Based on the total exposure, ie the aggregate number of orders, the broker will decide if it is wise to exit the market via hedging or leave the exposure open. Profit is made by effectively managing all orders coming in.
One way to understand the DD model is to imagine a trading account where orders constantly appear in your account rather than being initiated by the trader. An effective risk management team will know how to manage this book of orders to mitigate risk and generate profits. For this reason, a DD model doesn’t imply that losses of clients are purely the revenue of the broker.
Forex Consulting – Your Partner for Selecting a Reliable Forex Broker
Thank you for checking out our article. The summary above is a very general subject, to fully understand both concepts one must engage further on the topic. Nevertheless, we find the outline satisfactory for a basic understanding of how forex brokers earn revenue.
If you would like guidance in selecting a forex broker, our team is here to assist you. Don’t hesitate to reach out to us for further guidance.