Explanation of a Forex Broker
Why You Need The Big Banks Or Brokerage Houses
A forex broker is an intermediary between you and the "interbank." If you don't know what the interbank is, it's a term that refers to networks of banks that trade with each other. Typically a Forex broker will offer you a price from the banks that they have lines of credit and access to FX liquidity. Many forex brokers use multiple banks for pricing, and they offer you the best one available.
To get an account with a forex broker, it's a bit like opening a bank account.
It requires paperwork and identity verification and such. The whole process takes a few days. However, if you're just looking to test the waters, that is much easier, forex brokers offer demo accounts that you only need to provide minimal information to open. A demo or practice account allows you to get set up and get some practice trading until you're ready to get started with real money.
Forex Brokers Also Offer You Leverage
The ability to use forex leverage comes with every account, and it varies in an amount anywhere from 10:1 to 100:1. A 10:1 leverage means that for every $1 in your account, you have $10 to trade. Leverage is both good and bad as you can make exponential profits, but you can also suffer from mounting losses. The law requires forex brokers to disclose this, and they typically do in fine print. New traders usually get excited and blow their accounts out quickly if they jump in too fast.
There Are Two Balances
When you're working and trading with a forex broker, there are two balances. One balance is your actual balance, not including your open trades. Your other balance is the balance that you would have if you closed all your trades. The second balance is called your net balance.
When you open a forex trade with a broker, they pass it through to the market for you.
In the process of this, they offer you a price that is slightly different than the price they can get. This is called collecting the spread. The spread is a commission of sorts that is mostly transparent to trading from the trader's point of view. However, you always have to keep in mind that the beauty of the spread from the broker's point of view is that it's taken from your leveraged trade size, not your account balance size.
Forex is a relatively new arena for many investors. News that affects a stock price may have a radically different effect on the price of a currency. Also, learning how to price currencies and invest in them in a relative environment is often uncomfortable territory when a prospective investor first comes into FX. To battle the lack of knowledge that many have due to the uniqueness of the FX market, many brokers have set up divisions dedicated to education and research to help traders get up to speed and informed on a day-to-day basis. A popular destination is DailyFX.
Forex brokers exist to make it easier for you to connect with the banks out there that are buying and selling currencies. They have a set of rules that they have to follow and certain processes that are required.
It is comparable to having a bank account.