Updated: Jan 22
All traders have to deal with forex brokers when they venture into trading. It is important to understand the difference between brokers and traders, so that traders can make well-informed decisions.
A forex broker is a company that offers traders an electronic trading platform that allows them to buy and sell currencies and other financial products online. Introducing brokers (IB) are the marketing agents of the brokerage firm who are involved in persuading potential traders to open trading accounts. IBs are usually paid a fixed monthly salary as well as commissions from spreads (difference between bid and ask prices) every time their trading client opens up a new trade in their trading account.
A trader is a person who buys and sells currency or other financial products like stocks and commodities from the online trading platform provided by a specific broker of their choice. They do this by studying price behavior and employing various strategies in the hopes of generating profits.
The professional domains of people employed in brokerage firms and that of their clients i.e the traders, are different and can have conflict of interest. While all IBs or marketing agents know how to execute trades an have a basic understanding of financial instruments, they may not be trading their own accounts. Moreover, their income depends largely on the commissions generated from trading transactions of client traders. IBs are paid a part of the commission on every trade their clients take regardless of whether they profit or lose. The more a trader trades, and the higher the volume of trading, the more their marketing agent at the brokerage firm will make as commission income. On the other hand, the income of traders depends on the profits generated through successful trading strategies.
Unfortunately, IBs or broker marketing representatives may avoid telling traders to be selective or practice risk management by restricting trade volumes, as this can lead to lower commissions. The more selective or infrequent your trading, the more the brokerage company loses out as a whole. While many brokers are well intentioned, others might mislead you by:
Prompting you to over-trade. This could be done by sending you frequent trading signals, news reports or price analysis and then making frequent follow-up calls that push you to over-trade.
Suggesting you a fund management service. Although this is usually unauthorized for most forex brokers, they may offer your trading account to be handled by more ‘experienced’ forex fund manager. This may be supplemented with some dubious track record to get you on board with the fund manager on a profit sharing basis. The fund manager may excessively trade or ‘churn’ your trading account to generate more commissions for the brokerage firm, regardless of your trading account's performance.
Convincing you to subscribe to a signalling service (see my article ‘Why not to trade with a signals’) or selling you a trading robot: While these help generate extra revenues for the broker, they will not really help with your trading results.
Advising against crucial money management principles: This could be done by discouraging stop loss placement or prompting you to take bigger position sizes which increases broker comissions. If your account is on the verge of liquidation, your broking agent may persuade you to top up your account quickly to ‘save’ it and keep your trades running. Without a robust strategy and money management, adding more to capital to your account will usually result in the loss of this capital as well. Remember that your brokers may be the ‘market makers’ type which means that they are your counterparty in trading and all your losses are their profits.
As a trader, being aware of these intentional practices will save you from mental stress and losses and help you choose the optimal broker for yourself.