How do trading brokers make money?
Few traders take the time to understand where their money goes when they open a position with their broker, and how much it really costs. Keep reading to find out how trading brokers make money.
What is a broker?
A broker is an individual or a company that helps complete transactions between buyers, sellers or traders. They act as the middleman in many industries and provide execution services.
Within the finance industry, there are different kinds of brokers such as trading brokerages and stockbrokers – we act as both.
What is a trading broker?
A trading broker – like us – is a person or entity with direct market access that traders engage to buy and sell shares on the market. Your broker will manage and execute financial transactions for you, across several different types of markets, like shares and forex.
What is the difference between a trading broker and a stockbroker?
Trading brokers and stockbrokers might sound like they perform the same function, but there are some distinct differences. While stockbrokers focus on buying and selling shares, trading brokers might give you access to other markets like forex and indices.
The biggest difference between them is how they make their money. Stockbrokers usually make most of their money from the commission they charge. Trading brokers, on the other hand, tend to make their money from the spread, as well as commissions, overnight funding and other fees.
We act as both a stockbroker and a trading broker, giving you the best of both worlds. If you choose to trade with a broker like us, you’ll get access to over 18,000 markets including shares and several exclusive 24/7 opportunities.1
How do stockbrokers make money?
There are many ways that stockbrokers make money from their clients:
Commission
Typically, stockbrokers earn a living from the commissions charged to open or close positions for clients. This could be as a flat-rate, on a per-share basis or as percentage of your total trade value when you open and close a trade.
By choosing us as your stockbroker, you’ll get access to our low dealing costs and over 13,000 shares, funds and investment trusts to choose from. You’ll pay zero commission on US shares and just £3 per trade on UK shares.2
For example, you may choose to open a position worth £20,000 on Avast PLC. Another stockbroker may charge you a £20 flat-rate commission. This means that you’ll need to pay an extra £20, just to initiate the trade.
Within the same example, if the markets move against you and you choose to close your position after losing £4000, you’ll need to pay a commission again. The stockbroker would earn another £20, which you’ll have to pay even after encountering that loss.
If you’d made the same investment with us, you could have paid between £3 and £8 total commission.
Custody fees
To ensure that their clients stay engaged, stockbrokers often charge custody fees. Simply put, this is a small amount you’ll be charged monthly if your account has seen no trading activity for an extended period.
Unlike other brokers, our custody fees are fixed and do not grow alongside your portfolio. If you place three or more trades during a quarter, we’ll waive the fee entirely.
You’ll also be exempt from any share dealing custody fees if you invest £15,000 in one of our expertly managed Smart Portfolios.
Deposit and withdrawal fees
To open an account with most brokers, you’ll need to deposit a minimum amount of funds. This is to ensure that you have the necessary capital to take a position on the markets.
Some stockbrokers also charge you every time you deposit or withdraw additional funds from your account. Usually this is a flat rate, and not proportional to your transactions.
With us, you won’t be charged any fees for your standard bank transfers and opening an account is free.
Other fees
There are charges incurred for extra services like live newsfeeds, portfolio management and other premium services. These are optional extras that you can elect to use to enhance your experience.
Same-day and international bank transfers will also result in additional fees, and so will any telephonic dealing. Find a complete breakdown of our share dealing costs.
How do trading brokers make money?
Trading brokers make money in several different ways, including:
The spread
In contrast to stockbrokers, trading brokers derive most of their income from the spread. This means that there will be a difference between the price of the instrument itself and how much you’ll pay on your trade. If a trading broker chooses to add spreads to your trades, these charges should be fully disclosed on their website or platform.
For example, if Apple Inc share price is $140.02 and has a 1 point spread, it would have an offer price of $140.03 and a bid price of $140.04 on our platform.
It’s worth noting that spreads aren’t determined by brokers alone – they’re also affected by volatility, liquidity and trade volume.
Commission
Just like stockbrokers, trading brokers can also charge a commission to make money. As mentioned before, the commission will be charged as a flat rate or small percentage of your total trade size and applied when you open or close a position.
You should note that commissions can occur with specific trades only – for example, if you trade on shares using contracts for difference (CFDs) with us, and not on futures or forwards.
In fact, if you have an account with us, you’ll only pay commission on shares and ETF CFDs, not for any other leveraged markets.
Overnight fees
If you keep your position after markets have closed for the day, trading brokers may charge you an overnight funding fee. This fee is also a percentage-based charge that reflects the cost of funding your position overnight.
Overnight fees are most common if you’re trading using leveraged products, like CFDs. If you choose to trade with us, you’ll only incur overnight fees on spot trades, and not on futures contracts – although these will have a larger spread.
Deposit and withdrawal fees
Some trading brokers will charge you a small fee for every transaction that takes place on your account, including deposits and withdrawals. This may seem like a small price to pay, but if you’re an active day trader, these charges can accumulate in the long run.
Instead, why not trade with a broker like us? Any deposits and withdrawals completed via PayPal or credit card won’t cost you extra. There’s also no charge to open your account.
Trading against users
Some brokers earn a profit when their clients lose money on trades, which is something you’d want to avoid.
In this instance, brokers don’t hedge anything and instead accept all market risk, taking the position opposite to yours. The expectation is that you’ll fail, they will make a profit on the trade and earn an income on all fees, without having to pay you out for successful trades.
As a trading broker, we use internalisation to match your positions with other clients and hedge the rest. We always want you to succeed and provide a range of tools for you to do so.
Guaranteed stop premiums
To help you minimise your losses and protect you against slippage, many trading brokers like us offer guaranteed stops. This means that your position will close when it reaches the price you’ve selected.
If your guaranteed stop is triggered, you’ll be charged a small premium. This fee is subject to change, particularly in more volatile markets and over the weekend.
Other services
As a trader, you can choose to pay for several premium services offered by brokers. These charges also form part of how trading brokers make money.
Some examples of these extra services include direct market access, live data streaming and more advanced charting and analysis. Features like these can support your trading journey and you should consider whether the trading broker you choose offers these.
We include several other services, free of charge, including interactive online courses, on-demand webinars and expert analysis. Choosing us as your trading broker will also grant you access to weekend and out-of-hours trading on 80+ popular US stocks.
Trading brokers: hedging vs internalisation vs betting on clients losing
There are three main business models used by trading brokers:
- Hedging
- Internalisation
- Betting on clients losing
The first, hedging, is also known as the A-Book business model. It involves the broker transferring the risk of the position you wish to take to a third-party liquidity provider. This limits the risk they take on when opening your position, making this a sustainable business model.
Internalisation, or the hybrid business model, involves the broker trying to incorporate the hedging process with long and short positions taken by its own clients. This involves matching buys to sells to net them off, and then hedging the remainder.
We choose to follow this strategy as we don’t make a profit from our clients losing.
The final model is something that we don’t do. Often called the B-Book business model, it involves betting on clients losing and means that a broker will directly benefit from your losses by taking a position opposite to yours. These brokers are betting on the majority of their clients losing money.
Sources
1 24/7 excludes the hours from 10pm Friday to 8am Saturday (UK time), and 20 minutes just before the weekday market opens on Sunday night.
2 If you place 3 or more trades in the previous calendar month.
This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.
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