A common belief among traders is that brokers make money when traders lose. While this is true in certain cases, particularly for market makers who act as the counterparty to trades, the situation is more nuanced than simply stating that brokers profit from traders’ losses. Brokers, especially those that are ECN (Electronic Communication Network) or STP (Straight Through Processing), operate differently and do not profit directly from whether traders win or lose. Understanding how brokers make money is crucial for traders in order to demystify the relationship between the two parties and to avoid misconceptions about broker motives.

In reality, brokers have various business models, and how they make money depends on whether they are acting as market makers or non-dealing desk brokers (ECN/STP). The relationship between brokers and traders is not as adversarial as some may believe, and brokers can be profitable regardless of whether traders win or lose.

Why Some Traders Believe Brokers Make Money If You Lose

Several reasons contribute to the belief that brokers make money if you lose:

• Market Maker Business Model: In the market maker model, the broker acts as the counterparty to the trader’s position. When you buy or sell, the market maker takes the opposite side of the trade. In this model, if the trader loses, the broker profits, and if the trader wins, the broker loses. This creates the perception that brokers benefit from traders’ losses.
• Misunderstanding of broker types: Many traders mistakenly assume that all brokers are market makers and that brokers are always betting against them. In fact, many brokers are ECN or STP brokers, which means they pass the trade to liquidity providers, and the broker’s profit is based on commissions or spreads, not traders’ outcomes.
• Spread markups and commissions: Some brokers mark up the spreads or charge commissions on trades, and traders might assume that the broker’s business model is reliant on them losing money, as the broker earns from every trade regardless of the trade’s outcome.

While the market maker model does create a situation where the broker profits when traders lose, this is not the case for all brokers. Many brokers make money regardless of whether traders win or lose, especially those who use the ECN/STP models.

How Brokers Actually Make Money

There are different ways brokers earn money, and it depends on the type of broker and their business model. Here’s an overview of the main ways brokers make money:

1. Market Makers (Dealing Desk Brokers)

Market makers are brokers who take the opposite side of their clients’ trades. They act as the counterparty to their customers’ positions, which means that when a trader wins, the market maker loses, and vice versa. Market makers make money in the following ways:

• Spread markup: Market makers typically earn money by offering a spread that is wider than the actual market spread. The difference between the bid and ask price is how they profit. This spread markup is charged on every trade, regardless of whether the trader wins or loses.
• Internalisation of orders: In some cases, market makers may choose to internalise orders (fill them from their own books) instead of routing them to external liquidity providers. This means the broker may never need to match a client’s trade with the real market. In this case, the market maker profits from both the spread markup and the internalisation of orders.

2. ECN/STP Brokers (Non-Dealing Desk Brokers)

Unlike market makers, ECN (Electronic Communication Network) and STP (Straight Through Processing) brokers do not take the opposite side of their clients’ trades. Instead, they route orders directly to liquidity providers, such as banks or other financial institutions. Brokers in this category make money in the following ways:

• Commissions on trades: ECN/STP brokers earn money by charging traders a fixed commission per trade, regardless of the trade’s outcome. This means that brokers make money every time a trade is executed, whether the trader wins or loses.
• Spread markup: In addition to commissions, ECN brokers may also charge a small markup on the spreads they offer, which is how they make money from each trade. However, the spreads in the ECN model are typically tighter compared to market makers, since liquidity providers compete for the trade.
• Account fees and other services: Some brokers may charge account fees, withdrawal fees, or offer additional services such as premium research or trading platforms. These fees generate revenue for the broker, irrespective of whether the trader wins or loses.

In the case of ECN/STP brokers, the broker’s profit is largely tied to the volume of trades and the commissions or fees paid by traders, rather than the traders’ success or failure. This aligns the broker’s incentives with traders’ needs, as brokers profit by facilitating more trades, rather than by benefiting from traders’ losses.

3. Hybrid Brokers

Some brokers use a combination of both market maker and ECN/STP models. These brokers may act as market makers for some clients or trade types while routing other trades to liquidity providers. In this case, brokers can profit from both market-making spreads and commissions on trades routed to external liquidity providers. Hybrid brokers have a more flexible approach, allowing them to profit from multiple revenue streams, irrespective of the client’s success or failure.

Brokers and Their Incentives

The incentives for brokers can vary significantly depending on their business model:

• Market Makers: Brokers in this category may face a potential conflict of interest, as they take the opposite side of trades. However, they often offer fixed spreads and do not charge commissions, which can appeal to retail traders looking for low-cost trading. Their profit depends on trade volume, as more trades lead to more spread markup.
• ECN/STP Brokers: Brokers that use this model benefit from higher trade volume and the commissions paid by clients. These brokers don’t profit from traders’ wins or losses but instead focus on providing a reliable and efficient trading platform for their clients. The more trades their clients execute, the more commissions they earn.

Why Brokers Don’t Need Traders to Lose

For ECN and STP brokers, the focus is on volume. These brokers make money from the commissions and spreads on each trade, regardless of whether the trader wins or loses. Because their revenue is based on facilitating trades rather than being the counterparty, they don’t have an incentive for traders to lose. In fact, their profit is directly tied to the number of trades executed, so brokers in this model are more likely to prefer traders who trade often, whether they are winning or losing.

In the case of market makers, it’s true that they may profit when a trader loses, as they are taking the opposite side of the trade. However, many market makers aim to hedge their risk by passing on some of the trades to liquidity providers, so they are not solely dependent on their clients’ losses.

Conclusion

It is not accurate to say that brokers make money only if you lose. The way brokers generate revenue depends on their business model. Market makers may profit from traders’ losses due to their role as the counterparty to trades, but ECN and STP brokers earn money through commissions, spreads, and trade volume, regardless of whether traders win or lose. Brokers in these models align their interests with those of their clients, as they profit by providing a platform for traders to execute more trades.

Understanding how brokers make money and the different business models available can help traders choose the right broker for their needs and avoid misconceptions about the broker-client relationship.

To learn more about how brokers work, and how to choose the best one for your trading style, enrol in our expertly designed Trading Courses today.