Brokerage Revenues and Prime Functions
Tenth session of Forex Training
Welcome back to Forex professional training in financial markets. In this session we will talk about brokerage revenues and prime functions, broker’s cut or commission, and an offset.
Many people would like to know what brokers do and how they do it. We shall answer these questions in this session.
The first thing we need to do is to compare trades. The majority of trades are made based on major currencies such as EURUSD, GBPUSD and USDJPY.
Other less commonly traded currencies are GBPJPY and EURJPY, and in terms of goods, it is most often Gold that is traded.
Up to 70-75% of trades are made in EURUSD and GBPUSD, a broker will focus heavily on these currencies and monitor and compare them constantly.
As you know, there are always people active within the market; some of these people are anticipating a rise while others, a drop, meaning at all times there are many people looking to buy or sell.
Here is an example to make it clearer to you. Imagine that you have an order to buy 1,000 lots of gold and, at the same time, have an order to sell 1,000 lots of gold.
Rare as it may sound, it is a scenario a broker will face. In this instance it’s as if no transaction has been made. The broker’s commission will be between $100,000 and $140,000.
This commission is based off the calculation that 2,000 times the gold spread; in this case $50 or $70 equal to $100,000 or $140,000, respectively.
Most importantly, this commission is made without moving any trades at all. This scenario is possible with exchange shops.
For example, imagine there is $1 million dollars being transferred to a country that is transferring in $1 million dollars.
The two amount match and so no actual trade has been made.
Exchange shops offset capital within the country, providing commission to the brokers. If they were to pay $0.01 per $1 then their commission would be $10,000.
Next we will talk about overlapping. Brokers have arrangements with one another and based upon these they manage their customers’ accounts.
For instance, imagine we were to buy 10,000 lots and sell 11,000 lots; there is a difference of 1,000 lots. What the broker does now is overlapping.
They basically overlap their accounts and trades with other brokers, and based on the previously mentioned arrangements, divide the profits between themselves.
The next thing we will focus on is OTC law or Over the Counter Law.
Using risk management with world prices, brokers can deal with their customers directly, however, this depends on several things:
The customers’ country of origin
The country they opened their account in
Their turnover and transaction value
Currencies they trade and their flexibility
Their profit and losses
And finally, their initial capital
The number of trades made and those trade values are also considered here.
For example, a team of brokerage specialists came to the conclusion that today, the price of Gold would increase from 1,300 to 1,305.
Based on this prediction the broker can deal with Gold selling customers directly instead of transferring their orders to the inter-banking liquidity, hence the broker derives a huge amount of profit if Gold price rises to the predicted target price.
When exchangers consider that price of a currency would fall, they then sell that currency with the current price even if they do not have that amount of given currency.
After a period of time, when they want to deliver the sold currency, they buy that currency at a lower price and deliver the cash to the buyer.
For instance, an exchanger predicts that Turkish Lira (TRY) would become cheaper against the US Dollar (USD).
A party wants to buy 1 million TRY, hence he orders that amount.
Despite the fact that the exchanger sells the amount to the buyer, but he does not have that amount of money and he does not buy the remaining until the time that he should deliver that amount in cash.
Considering that the delivery time is 1 day later than the order time, the price of TRY falls considerably.
An Exchanger would buy the remaining amount at a lower price exactly at the delivery time.
An Exchanger derives a substantial amount of profit due to the delay between the order time and the delivery time.
Next we will look at increasing Spread.
When a market is fluctuating, a broker usually increases the spread to put more customers and traders, who placed orders after the spread increment, into one group.
For example, if the spread of buying or selling Gold increases from 5 or 7 pip up to 12 pip, a broker can put all customers between 24 pips channel which equals to $2.4 dollars distance and the broker can gain a substantial amount of profit from every party based on their entry price.
Commission for trading assets and STP accounts
The next topic is commission, which we have touched up on briefly before.
In the last session, about STP and NDD accounts, we explained how a broker gets commission as their revenue.
Brokers Swap Commission
However, brokers can also receive the commission from positive or negative swaps, this is called Brokers swap commission.
Brokers intend to open large accounts with banks or bigger brokers, and when they do not want to abide OTC law or if the amount of traded orders becomes larger than their overlapping capability, then they offset those trades into their accounts in those powerful brokers or banks.
In this way they can still make profit from their trades.
For example, in EURUSD trades from a typical broker, the offer would be 2 pip, while the bank provides 0.3 pip spread on EURUSD to the given broker, due to its large account balance, leaving the broker with a 1.7 pip profit.
Next we will talk about the use of a negative offset swap.
As you know, swap free accounts, do not charge for swap, and brokers with a negative swap intend to open accounts in swap free account, then transfer exact funds and orders to these accounts.
This way they do not pay any swap but they can still charge traders for negative swaps as well as their commission every night.
Well, in this session we have explained all different types of broker’s commission.
All the information above is related to the internal policy of brokerage.
It has nothing to do with account type such as floating spread, fixed spread, STP, ECN or NDD and all brokers are obliged to pay any profit, by any party in any trade at any time.
That concludes this session, until next time and another session take care.