What Is A Forex Broker?

A forex broker, also known as a retail forex broker or currency trading broker, is an intermediary who buys and sells currency pairs for a commission. A broker may be thought of as a financial services practitioner or as a salesman of assets. Although the origin of the term is unclear, it is thought to stem from old French.

Since the beginning of the modern trading era, the role of the broker has commonly been found in equities, commodities, derivatives and even insurance and real estate markets. And, until the dawn of the internet age, most brokers operated by phone. Clients could phone in their orders of trades, and brokers would buy and sell assets on behalf of their client's accounts for a percentage-based commission.

Under this broker-assisted system, new traders faced many barriers to entry. Among the most significant was exorbitant service pricing, lofty account minimums and convoluted order routing. Simply put, it wasn't easy to start trading.

However, with the advent of internet technology, many brokers began allowing their clients to access accounts and trade through electronic platforms and computer applications. Accordingly, remote trading was born and hundreds of online forex brokers came into existence. The result was a much deeper forex market driven by vastly greater participation.

In the past, a broker was considered an individual member of a profession and often worked at a special agency known as a brokerage house (or simply a brokerage). Today, the term "broker" is often used as shorthand for a brokerage.^[1] Subsequently, online forex brokers have grown in popularity and help facilitate trillions of pounds worth of daily foreign currency market turnover.

Retail Forex

A key concept for modern individual traders is the retail foreign exchange market (forex). Traditionally, foreign exchange has been traded on the interbank market by larger clients such as importers, exporters, banks and multinational corporations. Each of these institutional participants have a need to trade currencies for commercial purposes or to hedge against international currency risks.

Retail forex is forex that is traded through dealers, often by smaller or individual investors. These firms are also known by the term "retail aggregators." Retail forex trading began to become popularised in the late 1990s with the emergence of internet-based financial trading. At that time, retail forex brokers and dealers went into business to allow smaller traders to get into markets that were previously limited to large-scale businesses and financial institutions.^[2]

As time passed, forex trading became a popular endeavour for retail capital market participants. Evolving technology brought aspiring forex traders into the market from all corners of the earth. No longer did one have to be located near a formal exchange to participate; residents from Japan, Australia, Great Britain and the United States were all able to engage the global currency markets. Due to the expansion of accessibility, the foreign exchange market grew to being the largest trading venue in the world.^[6]

Retail brokers typically allow traders to set up a forex trading account with a limited amount of assets and let them trade online through internet-based trading platforms. Most trading is done via the spot currency market, though some brokers deal in derivative products such as futures and options. In either case, traders are able to seek profit from beneficial moves in foreign currency exchange rates.

Forex trading has been popularised among individual traders because brokers have offered them the chance to trade with margin accounts. These allow traders to effectively borrow capital to make a trade, and multiply the principal that they use to trade by large amounts, up to 50 times their initial capital.^[3] This availability of leverage furnishes participants with greater capital efficiency and the ability to implement a variety of forex trading strategies.

Brokers And Dealers

Most retail forex brokerages act in the role of dealers, often taking the other side of a trade in order to provide liquidity for traders. Brokers make money with this activity by charging a small fee through a bid-ask spread. Before the emergence of retail forex brokerages, individual trading amounts less than US$1 million were discouraged from entering the market by high bid-ask spreads.^[3] Unfortunately for everyone else, the ability to trade forex simply wasn't feasible.

Around the year 2000, retail brokers began offering online accounts to private investors, streaming prices from major banks and the Electronic Broking Services (EBS) system. As a result, brokerages were able to provide retail service by bundling many small trades together and negotiating them in the bank-dominated interdealer market. Because the trade volumes were much larger, participants in the interdealer market were willing to provide liquidity for the retail brokers' accessible prices.

Generally, bid-ask spreads are higher for retail customers than they are in the interdealer market. However, as the trading volume rises, the bid-ask spread tightens in response to the enhanced market depth.^[4] Therefore, a EUR/USD bid-ask spread is likely much smaller when there are one thousand standard lots in queue rather than one.

Dealing Desk

Typically, retail forex traders can only access the market through a broker. However, forex brokers often offer two modalities of trading.

Dealing Desk Trading

The first is "dealing-desk" trading, where brokers act as dealers and take the opposite position of a trader. Traders may pay larger spreads on average in such trades, and orders can be filled on a discretionary basis by the broker. For instance, if someone is trading the U.S. dollar (USD) against the Australian dollar (AUD), the broker will be on the other side of the AUD/USD buy or sell. While dealing desk execution guarantees liquidity, it also raises questions regarding accurate pricing.

No Dealing Desk Trading

The other type of service is "no dealing desk" trading. Traders are given direct access to the interdealer market, but they may be charged a fee for this service. They also could be exposed to wider variable spreads on occasion, depending on market conditions.^[5] Despite the fees and variable spreads, many traders prefer to directly engage the interdealer market when trading major currency pairs. Frequently, the potential of locking-in a superior price outweighs the downsides of no-dealing desk trading.

Other Services Offered By Brokers

From Sydney, Australia to London, England, hundreds of firms compete to earn the reputation of best forex broker. To do so, many offer a comprehensive service suite that includes many enhanced features. In addition to helping clients buy and sell assets, the following auxiliary services may be offered:

• Information like news feeds and research services
• Asset price charting
• Live demo account access
• Trainer trading programs and advice
• Professionally managed accounts

Some of these services may be offered for free and others may involve the payment of a fee.

Summary

Forex brokers offer an essential service for markets, especially for retail forex traders. Since they began operations in the retail market, brokers have helped open up a field of opportunity that previously wasn't available to individual traders.

Now, it's simple to trade forex. With an internet connection and a computer or mobile phone, traders can now open an account and trade in a market that was previously only accessible to banks, high-net worth investors, large companies and financial institutions. Brokers also offer services that can be valuable in assisting traders to understand price movements and potentially make profits.

If you're an aspiring retail forex trader, then the time has never been better to enter the market. No matter if the Japanese yen (JPY), British pound (GBP), or euro (EUR) is your speciality, the forex marketplace has a collection of exciting currency pairs for trade. Choose the best forex broker you can find, check out a demo account and get started today.