Chapter 13. Income of Forex Participants

As we have discussed many times before, private individual traders enter the Forex market through an Internet broker or a dealing company. Internet traders make money through currency speculation by closing positions at more advantageous exchange rates than the ones at which they were opened. Trading in the Forex market is a risky business for Internet traders. The effectiveness of working in the currency market can vary depending on the trading strategy employed (strategies will be discussed in the Forex School section). Another important factor for success is the trader's personal characteristics, including their ability to control emotions and make well-informed decisions.

Internet brokers in the Forex market, on the other hand, can be considered a business. In this business, there is virtually no risk. The principle of margin trading, as discussed in the corresponding chapter, prevents a client of a dealing company from losing more funds than what is available in their account and "digging into the pockets" of the Internet broker..

Correct, the dealing company in the Forex market operates based on a business model. They maintain multi-currency accounts with a bank that provides them with quotes, and the dealing company, in turn, provides these quotes to its clients. Usually, the quotes offered to Internet traders have a slightly wider spread compared to the interbank level. This allows the dealing company to profit from the difference in spreads since interbank transactions are executed at more favorable quotes. Let's consider an example. Suppose the bank provides the dealing center with a USD/JPY quote of 104.75/104.77 with a 2-pip spread. The dealing center increases the spread to 4 pips and offers its clients a USD/JPY quote of 104.74/104.78. Now, imagine an Internet trader opens a short position (sells US dollars) with a volume of one lot, which is equal to 100,000 dollars. The trader sells dollars at a rate of 104.74 yen per dollar, while at the interbank level, the transaction is executed at a rate of 104.75 yen per dollar. The difference amounts to 100,000 * (104.75 - 104.74) = 1,000 Japanese yen, which is approximately 1,000 / 104.77 = 9.54 dollars based on the interbank exchange rate. This amount represents a stable income for the dealing company, which is not associated with any risk. It's important to note that this is only the income from the client's position opening. The dealing company earns a similar amount when the position is closed. In total, the dealing company can earn around 19 dollars from the trade. If the dealing company has thousands of clients who execute dozens of trades per day, their daily income can reach hundreds of thousands of dollars! As you can see, it is a highly profitable business.

But the spread may not be the only source of income for internet brokers. Some dealing companies may charge a commission for the trade or even separate commissions for opening and closing positions. In principle, such a commission is similar to the income from the spread. For example, in our example, the dealing company may provide clients with the interbank quote USD/JPY 104.75/104.77 directly (without widening the spread) but charge the client $19 for each trade. This results in the same profit. It should be noted that some internet brokers may both charge a commission and widen the interbank spread. However, in practice, it is difficult to verify whether a dealing company widens the interbank spread or not, as quotes constantly change and the exact interbank spread is unknown to the internet trader.

The described method of income for a dealing company applies when an internet trader uses standard lot sizes in their forex trading. However, if mini or micro lots are used, the situation is somewhat different. The dealing company cannot execute a trade of such a small amount through a bank at the interbank level. One mini lot is equivalent to $10,000, and one micro lot is equivalent to $1,000. The minimum trade size at the interbank level is $100,000. How are trades conducted in this case? Here, simple statistics come into play - up to 95% of novice internet traders lose their money when trading forex. This usually happens because most people who start trading forex are looking for easy money. They do not thoroughly study the theory of the currency market, its analysis tools, or the impact of economic indicators on exchange rates. For such individuals, forex trading turns into a game of roulette. It is precisely because mini and micro lots are typically traded by beginners and amateurs that dealing companies do not execute trades for these lot sizes at the interbank level. If an internet trader closes a position with a loss on a mini or micro lot, the dealing company profits from those losses. However, if an internet trader closes a position with a profit on a mini or micro lot, the dealing company pays out that profit. Since 95% of novice traders eventually lose their money, the remaining 5% would need to generate profits greater than the losses of those 95% in order to bankrupt the dealing company. Assuming that the initial account size for each trader is the same, this profit would need to increase by a factor of 19, which is highly unlikely. Moreover, if an internet trader is very successful trading mini lots, they will eventually transition to standard lots, where the dealing company no longer pays them income from its own pocket but executes trades through a bank at the interbank level.

The alternative earning method described above is not openly advertised by dealing companies. Most of them claim that all trades are executed at the interbank level, regardless of the lot size. However, common sense and logical reasoning lead to the opposite conclusion. It is possible that the truth lies somewhere in between. Each individual decides for themselves what to believe and what not to believe. However, it is crucial to understand that the majority of novice traders lose their money. It is possible to earn on Forex, and it is not a myth. But simply clicking the "earn a million" button is not enough. Forex trading is a risky business that requires specific knowledge, skills, and abilities from the internet trader.

An additional source of income for a dealing company can be the bank interest described in the previous chapter. However, the income from it is usually insignificant, and to obtain it, the open position should not be closed for an extended period. It is much more profitable for an internet broker if positions are opened and closed by internet traders as frequently as possible. As described earlier, each completed trade brings income to the internet broker in the form of commissions or through the spread. The income from bank interest is minuscule compared to the income from commissions and spreads. It should be noted that dealing companies can both earn from bank interest and pay it out, as detailed in the previous chapter.

As we can see, dealing companies are in a more advantageous position than internet traders. They have a stable income, and their business can be confidently called successful. Dealing companies earn income from spreads, commissions, bank interest, and the unsuccessful trades of their small clients who trade with mini and micro lots. The income of internet traders is limited to successful trades on currency exchange rates (currency speculation) and, in some cases, bank interest. However, despite this, Forex trading is very attractive. If this activity is approached as a "job" rather than a "game," it is possible to achieve stable and high income. In such cases, the profitability can exceed the returns from investing in securities, bonds, or mutual funds. However, if you succumb to temptation and start trading on Forex without sufficient knowledge and skills, there is a high probability of losing your money. Now you have good advice, but the ultimate decision is up to you!

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