Before the popularity of spot Forex trading, investors typically make use of currency futures trading to take part in the movement of the different currencies pairs.
Spot Forex Brokers Are Everywhere
It is very easy to find a local Forex broker or an online one. A spot Forex trading account can also be opened from within a day to within a few days. It is extremely attractive to trade Forex.
One, there are no commission charges. Two, the price data is free of charge. You can practically get data for all the time frames, from 5 seconds, 30 minutes up to hourly intervals. Three, trading platforms provided by the brokers features real-time charting, and you can apply any technical indicators for your technical analysis. Four, some platforms offer programmable tool for you to trade the currencies automatically.
With so many freebies, how do the brokers make any money at all?
How the Spot Forex Brokers Made Money
A spot Forex currency has 2 prices, a bid price and an ask price. They are simply the price you would want to buy from another person holding the currency, and the price someone holding the currency would want to sell to you.
Say, euro/usd is trading at 1.4400 now, with a bid price of 1.4420 and an ask price of 1.4380. If you think euro/usd is going to go up from 1.4400, you will buy euro/usd with a price of 1.4420. Fair and square, the seller would have made at least (1.4420 – 1.4400 = 0.0020 or 20 pips) from you. As euro/usd is still trading at 1.4400, you are making an immediate paper loss of 20 pips.
If you think euro/usd is going to go down, you will sell euro/usd with a price of 1.4380. Similarly, an immediate paper loss of 20 pips since euro/usd is at 1.4400 now. As you are not holding any euro now, you are effectively borrowing euro/usd at a price of 1.4380. If you were to return the borrowed amount immediately, you will need to buy back at 1.4420.
This is an extreme example. The spread or the difference between the bid and ask price is usually between 1 to 15 pips, depending on the spot currencies that you are trading in. Each spot Forex broker is acting as the seller or buyer when you want to go long or short respectively and they made money from the spread.
Many people might not know that when they trade with a spot Forex broker, the trades are not placed in the interbank market, but merely held on the broker’s own books. They are the counter party. When your positions go against you, the brokers actually gained. When your positions worked for you, the brokers lose.
Currency Futures Trading – Alternative to Spot Forex
For those who want to trade directly in a regulated marketplace with price transparency, consider E-mini currency futures trading offered by the Chicago Mercantile Exchange or CME. You would be able to trade in currency futures with a futures broker. There is very tight spread and commission offered is very low as well. There is also no conflict of interests as the trade is made in the actual futures exchange.
In general, if you are starting out in trading and has very little capital, for example $2k or less, a spot Forex broker gives you the opportunity to try out and participate in the currency price movements. For example, you can buy or sell $1,00 worth of euro/usd with a gain or loss of 1 cents for every 1 pip movement. If you are not a scalper and are willing to hold on to positions for a longer period, you would not be affected by the spread so much.
For traders with a day or shorter term trading style, currency futures trading is definitely the way to go.