Many retail forex traders don’t really know what happens behind the scenes when they place a trade.
This article gives you a practical understanding of how forex brokers work, how they manage their risk, and how they make money.
Once you understand this, you’ll be in a better position to choose a broker wisely.
Let’s break it down.
1. Are Forex Brokers Really Brokers?
Nope — not in the traditional sense.
A broker usually connects buyers with sellers. But in retail forex, your so-called “broker” doesn’t connect you to anyone. Instead, they take the opposite side of your trade. That means they’re actually dealers, not brokers.
For example:
- You want to buy EUR/USD → The broker sells it to you.
- You want to sell USD/JPY → The broker buys it from you.
So technically, they’re your counterparty, not your representative.
In the U.S., these firms are even officially called Retail Foreign Exchange Dealers (RFEDs).
2. Client vs. Customer – What’s the Difference?
If you think you’re a client, that means you believe your broker is working in your best interest.
But that’s not the case.
Your broker is not acting on your behalf — they’re just offering a platform so you can speculate on currency prices. There’s no fiduciary duty (legal responsibility to act in your best interest). So, you’re not a client.
You are a customer.
Your broker:
- Sells when you buy.
- Buys when you sell.
3. Your Trade Doesn’t Reach the Market
Many traders think their trades go into some giant global forex market.
That’s not how it works in retail forex.
Your trade stays within the broker’s system. It’s a private agreement between you and your broker, also known as a bilateral transaction. You don’t trade with other traders — only with the broker.
4. Understanding Market Risk
When you open a position:
- You take on market risk (you could lose if the market moves against you).
- Your broker also takes risk because they are holding the opposite position.
Example:
- You go long GBP/USD (buy).
- Your broker goes short GBP/USD (sell).
If GBP/USD rises:
- You win.
- Your broker loses.
If GBP/USD falls:
- You lose.
- Your broker wins.
This is called market risk.
But brokers have ways to manage this risk…
5. How Brokers Offset Risk
Let’s say two traders open opposite positions:
- Elsa goes long GBP/USD.
- Ariel goes short GBP/USD.
The broker takes the opposite side of both trades:
- Short against Elsa.
- Long against Ariel.
If both positions are the same size, the broker’s net position is zero — their risk is neutralized.
This is called internal hedging or position netting.
But what if there’s an imbalance (more traders are long than short)? That’s when brokers might:
- Hedge externally by opening a position in the real market.
- Accept the risk and rely on statistical probability (most traders lose over time).
- Use risk management algorithms to monitor exposure in real-time.
6. How Brokers Make Money
Brokers make money mainly in two ways:
a. The Spread
This is the difference between the bid price (what you sell at) and the ask price (what you buy at).
Example:
- Bid: 1.2500
- Ask: 1.2503
- Spread: 3 pips
The broker buys at 1.2500 and sells at 1.2503 — pocketing the difference.
b. Trading Against You
If a broker doesn’t hedge your trade externally and you lose, they keep your losses as profit. This is known as B-booking (internalizing your trade).
Some brokers also offer commissions, overnight swap fees, and premium services to increase their earnings.
7. What You Should Watch Out For
Since brokers are your counterparties, conflicts of interest can happen. That’s why it’s important to choose a broker that is:
- Well-regulated (like FCA, ASIC, or NFA regulated).
- Transparent about their execution model (Do they use a dealing desk? Do they hedge trades?).
- Fair with spreads and fees.
Conclusion
Retail forex brokers are not really brokers — they are dealers who trade against you. They make money through spreads, trading profits, and sometimes commissions.
While some brokers hedge their risk, others rely on the assumption that most retail traders lose.
By understanding how your broker operates, you can make smarter choices and better manage your own trading strategy.
Knowledge is power in the markets. 💡
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