{"id":9489,"date":"2022-10-12T06:53:55","date_gmt":"2022-10-12T06:53:55","guid":{"rendered":"https:\/\/mdr.foobrdigital.com\/?p=9489"},"modified":"2022-10-12T06:53:55","modified_gmt":"2022-10-12T06:53:55","slug":"how-a-book-brokers-make-money","status":"publish","type":"post","link":"https:\/\/mudassirbackup.infinitycodestudio.com\/index.php\/2022\/10\/12\/how-a-book-brokers-make-money\/","title":{"rendered":"How A-Book Brokers Make Money"},"content":{"rendered":"\n<p>Not sure you noticed in the previous two examples in the\u00a0<strong>previous lesson<\/strong>, but the A-Book broker did\u00a0<em>NOT\u00a0<\/em>make any money.<\/p>\n\n\n\n<p>The examples were shown this way to keep the focus on how the broker offloaded its market risk.<\/p>\n\n\n\n<p>So&nbsp;<strong>how do A-Book brokers make money<\/strong>?<\/p>\n\n\n\n<p>Unlike a\u00a0B-Book broker, an A-Book broker does NOT make money when its customers\u2019 trades lose.<\/p>\n\n\n\n<p>But an A-Book broker is not a charity. It\u2019s a business and needs to generate revenue.<\/p>\n\n\n\n<p>Understanding how a broker generates revenue helps you understand their incentives. And focusing on the incentives will help you assess whether their interests align with yours.<\/p>\n\n\n\n<p>Now that the risk transfer process has been explained, let\u2019s add in more details and see how A-Book brokers actually make money.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\">How A-Book Brokers Make Money<\/h2>\n\n\n\n<p>When a broker acts as an \u201cA-Book broker\u201d if a customer clicks \u201cBuy\u201d for an asset (e.g. currency pair), it:<\/p>\n\n\n\n<ul><li>immediately sells the asset to the customer, either at the&nbsp;<strong>same price that i<\/strong>t receives from its LP (with a \u201ccommission\u201d) or with a&nbsp;<strong>markup<\/strong>&nbsp;(with no commission). and then<\/li><li>immediately buys the currency pair from the LP for its own account and records that transaction in its own trading book.<\/li><\/ul>\n\n\n\n<p>If your broker is not taking any risk on the trade, there are two primary ways for an A-Book broker to make money:<\/p>\n\n\n\n<ol><li><strong>Commission<\/strong><\/li><li><strong>Spread Markup<\/strong><\/li><\/ol>\n\n\n\n<h3 class=\"wp-block-heading\">Commission<\/h3>\n\n\n\n<p>In the previous examples, Elsa (the customer ) and the broker had the&nbsp;<strong>same entry and exit prices<\/strong>.<\/p>\n\n\n\n<p>The way the broker can make money here is by charging Elsa a&nbsp;<strong>commission<\/strong>.<\/p>\n\n\n\n<p>Commissions are normally charged according to the size of your trade. The way it\u2019s expressed can vary between brokers.<\/p>\n\n\n\n<p>It can be charged&nbsp;<strong>per lo<\/strong>t,&nbsp;<strong>per million USD<\/strong>, or as a<strong>&nbsp;percentage of the trading volume<\/strong>.<\/p>\n\n\n\n<p>For example, a broker may charge you $60 per $1M or $6 per standard lot.<\/p>\n\n\n\n<p>Depending on the broker, discounted commissions may be offered based on your trading volume.&nbsp;The more you trade, the bigger the discount.<\/p>\n\n\n\n<p>For example, if you trade over $100M volume per month, instead of paying $60 per $1M, you might receive a 33% discount, and your commission would be reduced to $40 per $1M.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">Spread Markup<\/h3>\n\n\n\n<p>The other way an A-Book broker can make money is by applying a&nbsp;<strong>price markup&nbsp;<\/strong>or&nbsp;<strong>\u201cmarking up the spread\u201d<\/strong>.<\/p>\n\n\n\n<p>This is where a broker<strong>&nbsp;adds an extra amount to the pricing for its customers.<\/strong><\/p>\n\n\n\n<p>The broker makes money because the prices it trades with its liquidity providers (LPs) are&nbsp;<strong>better<\/strong>&nbsp;than the prices it trades with its customers.<\/p>\n\n\n\n<p>The&nbsp;<strong>markup<\/strong>&nbsp;is the difference between the price shown to the clients and the price taken from the LPs.<\/p>\n\n\n\n<p>This markup is similar to buying food at your grocery store.<\/p>\n\n\n\n<figure class=\"wp-block-image\"><img decoding=\"async\" src=\"https:\/\/bpcdn.co\/images\/2021\/05\/25161629\/grocery-retail-store-360x246.png\" alt=\"Grocery Retail Store\" class=\"wp-image-203331\"\/><\/figure>\n\n\n\n<p>The store pays \u201c<strong>wholesale<\/strong>\u201d prices and charges you a \u201c<strong>retail<\/strong>\u201d price. The difference between the two prices is the&nbsp;<strong>markup<\/strong>.<\/p>\n\n\n\n<p>This is how the grocery store makes money in exchange for providing you a service (access to food).<\/p>\n\n\n\n<p>Otherwise, it would make no profit and be out of business.<\/p>\n\n\n\n<p>The same concept applies to the A-Book broker. In exchange for providing a service to its customers (ability to speculate on currency prices), it makes money by adding a price markup.<\/p>\n\n\n\n<p>It pays \u201cwholesale\u201d prices from liquidity providers and charges you \u201cretail\u201d prices.<\/p>\n\n\n\n<p>Essentially, an A-Book broker acts as a&nbsp;<strong>liquidity retailer<\/strong>.<\/p>\n\n\n\n<figure class=\"wp-block-image\"><img decoding=\"async\" src=\"https:\/\/bpcdn.co\/images\/2021\/06\/07101025\/liquidity-retailer-360x360.png\" alt=\"Forex Broker as Liquidity Retailer\" class=\"wp-image-204400\" title=\"Forex Broker as Liquidity Retailer\"\/><\/figure>\n\n\n\n<p>Let\u2019s look at an example to see how this works.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\">Price Markup Example: Buy EUR\/USD<\/h2>\n\n\n\n<p>In this example, the broker adds a price markup of&nbsp;<strong>0.0001<\/strong>&nbsp;or&nbsp;<strong>1 pip<\/strong>.<\/p>\n\n\n\n<figure class=\"wp-block-image\"><a href=\"https:\/\/bpcdn.co\/images\/2021\/04\/26120641\/a-book-markup-example-1-a.png\"><img decoding=\"async\" src=\"https:\/\/bpcdn.co\/images\/2021\/04\/26120641\/a-book-markup-example-1-a-720x780.png\" alt=\"A-Book Srpead Markup Example\" class=\"wp-image-200910\" title=\"A-Book Spread Markup Example\"\/><\/a><\/figure>\n\n\n\n<p>Elsa opens a long EUR\/USD position at&nbsp;<strong>1.2001<\/strong>.<\/p>\n\n\n\n<p>Her position size is 3,000,000 units or 30 standard lots. This means a 1-pip move equals $300.<\/p>\n\n\n\n<p>Notice how the broker buys&nbsp;<strong>lower<\/strong>&nbsp;from the LP than it sells to Elsa.<\/p>\n\n\n\n<p>It bought EUR\/USD at 1.2000 from the LP but sold EUR\/USD to Elsa at 1.2001.<\/p>\n\n\n\n<p>This is the&nbsp;<strong>1-pip price markup<\/strong>&nbsp;in action.<\/p>\n\n\n\n<p>When Elsa exits her trade, a price markup also occurs.<\/p>\n\n\n\n<p>Notice how the broker sells&nbsp;<strong>higher<\/strong>&nbsp;to the LP than it buys from Elsa.<\/p>\n\n\n\n<p>The LP is willing to buy EUR\/USD at 1.2100, so the broker quotes Elsa 1.2099, to ensure it makes a profit on the transaction.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">Scenario #1: EUR\/USD Rises<\/h3>\n\n\n\n<p>As you can see, EUR\/USD ended up rising.<\/p>\n\n\n\n<p>Elsa ended up with a&nbsp;<strong>profit of 98 pips<\/strong>, which means her counterparty, the broker, ended up with an equivalent loss.<\/p>\n\n\n\n<p>But\u2026the broker was also in a<strong>&nbsp;separate trade with an LP<\/strong>.<\/p>\n\n\n\n<p>In this trade, the broker ended up with a profit of 100 pips, which means its counterparty, the LP, ended up with a&nbsp;<strong>loss of 100 pips<\/strong>.<\/p>\n\n\n\n<p>The profit made from its trade with the LP exceeds the loss incurred from its trade with Elsa (due to price markup), so the broker made an overall net profit of&nbsp;<strong>2 pips or $600<\/strong>&nbsp;($300 x 2 pips).<\/p>\n\n\n\n<p>Notice how when Elsa \u201cwon\u201d here, the broker did not \u201close\u201d.<\/p>\n\n\n\n<p>Because the broker had transferred the market risk to the LP, it avoided a loss when Elsa\u2019s trade won.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">Scenario #2: EUR\/USD Falls<\/h3>\n\n\n\n<p>Let\u2019s see what happens if EUR\/USD falls instead and Elsa ends up with a losing trade.<\/p>\n\n\n\n<figure class=\"wp-block-image\"><a href=\"https:\/\/bpcdn.co\/images\/2021\/04\/26120729\/a-book-markup-example-1-b.png\"><img decoding=\"async\" src=\"https:\/\/bpcdn.co\/images\/2021\/04\/26120729\/a-book-markup-example-1-b-720x780.png\" alt=\"A-Book Markup Example: EURUSD Falls\" class=\"wp-image-200911\" title=\"A-Book Markup Example: EURUSD Falls\"\/><\/a><\/figure>\n\n\n\n<p>In this example, Elsa opens a long EUR\/USD position at<strong>&nbsp;1.2001<\/strong>.<\/p>\n\n\n\n<p>Her position size is 3,000,000 units or 30 standard lots. This means a 1-pip move equals $300.<\/p>\n\n\n\n<p>EUR\/USD falls hard.<\/p>\n\n\n\n<p>Elsa decides to cut her losses and exits at 1.699, ending up with a<strong>&nbsp;loss of 302 pips or $90,600<\/strong>&nbsp;($300 x 302 pips).<\/p>\n\n\n\n<p>Since the broker is her counterparty, this means that the broker ended up with an equivalent gain.<\/p>\n\n\n\n<p>But\u2026the broker was also in a separate trade with an LP.<\/p>\n\n\n\n<p>In this trade, the&nbsp;<strong>broker ended up with a loss of 300 pips<\/strong>, which means its counterparty,&nbsp;<strong>the LP, ended up with a gain of 300 pips<\/strong>.<\/p>\n\n\n\n<p>The profit made from its trade with Elsa exceeds the loss incurred from its trade with the LP, so the broker still made an overall net&nbsp;<strong>profit of 2 pips or $600<\/strong>&nbsp;($300 x 2 pips).<\/p>\n\n\n\n<p>Notice how the broker\u2019s P&amp;L ended up being the same regardless of whether EUR\/USD went<strong>&nbsp;up or down.<\/strong><\/p>\n\n\n\n<p>Because the broker had transferred the market risk to the LP,&nbsp;<strong>it missed out on the 302 pips it would\u2019ve gained if it had just internalized the risk<\/strong>.<\/p>\n\n\n\n<p>But that\u2019s the tradeoff for hedging.<\/p>\n\n\n\n<p>When a trade is \u201cA-Booked\u201d, the advantage to a broker is that it\u2019s no longer exposed to potential LOSSES due to price movements, but the disadvantage is that it\u2019s also no longer exposed to potential GAINS due to price movements.<\/p>\n\n\n\n<p>The broker\u2019s revenue comes strictly&nbsp;<strong>from price markups<\/strong>.<\/p>\n\n\n\n<p>As you\u2019ve just learned, since an A-Book broker is not taking any risk on the trade, they make money by&nbsp;<strong>\u201cmarking up\u201d the spread or charging a commission<\/strong>.<\/p>\n\n\n\n<p>This business model removes any potential conflicts of interest since the broker would earn the same amount of money&nbsp;<strong>regardless of whether its customers win or lose<\/strong>.<\/p>\n\n\n\n<p>The broker makes money&nbsp;<strong>regardless of how the market moves<\/strong>.<\/p>\n\n\n\n<p>Of course, this all assumes that the A-Book broker has the&nbsp;<strong>backend technology to act quickly and without errors when hedging customer orders<\/strong>.&nbsp;<\/p>\n\n\n\n<h2 class=\"wp-block-heading\">How A-Book Brokers Make Money<\/h2>\n\n\n\n<p>Here is a simplified model of how an A-Book broker makes money:<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">Spread Markup Example<\/h3>\n\n\n\n<p>Let\u2019s look at a simple example of how to calculate a spread markup.<\/p>\n\n\n\n<p>On average, a raw institutional spread on EUR\/USD is around&nbsp;<strong>0.1 pip<\/strong>&nbsp;and this is paid by the A-Book broker.<\/p>\n\n\n\n<p>There\u2019s also an A-Book volume fee that needs to be added to the broker\u2019s costs.<\/p>\n\n\n\n<p>For EUR\/USD, it\u2019s around $2 USD per lot, and that equals&nbsp;<strong>0.2 pip<\/strong>.<\/p>\n\n\n\n<p>Let\u2019s add these up:<\/p>\n\n\n\n<pre class=\"wp-block-preformatted\">0.1 pips + 0.2 pips = 0.3 pips<\/pre>\n\n\n\n<p>Since the average spread in the retail market for EUR\/USD varies from 1 to 1.5 pip, and the A-Book broker\u2019s institutional cost equals&nbsp;<strong>0.3&nbsp; pip<\/strong>, adding a 1 pip markup will set the final retail spread at&nbsp;<strong>1.3 pips<\/strong>.<\/p>\n\n\n\n<p>This equates to&nbsp;<strong>$13 USD per standard lot<\/strong>&nbsp;or&nbsp;<strong>$1.30 USD per mini lot<\/strong>&nbsp;or&nbsp;<strong>$0.13 per micro lot<\/strong>.<\/p>\n\n\n\n<p>So for every standard lot, the broker will make&nbsp;<strong>$10<\/strong>.<\/p>\n\n\n\n<figure class=\"wp-block-table is-style-regular\"><table><tbody><tr><td><\/td><td>Liquidity Provider (Raw Spread)<\/td><td>Trading Platform\u2019s A-Book Volume Fee<\/td><td>Broker\u2019s<br>Markup<br>(pips)<\/td><td>Retail Spread<br>(pips)<\/td><td>Retail Spread (USD)<\/td><td>Income on each lot (pips)<\/td><td>Income on each lot (USD)<\/td><\/tr><tr><td>EUR\/USD<\/td><td>0.1<\/td><td>0.2<\/td><td>1<\/td><td>1.3<\/td><td>$13<\/td><td>1<\/td><td>$10<\/td><\/tr><tr><td>A-Book Transaction Fee<\/td><td>0.3<\/td><td><\/td><td><\/td><td><\/td><td><\/td><td><\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n<p>And for every mini lot, the broker will make&nbsp;<strong>$1<\/strong>.<\/p>\n\n\n\n<figure class=\"wp-block-table is-style-regular\"><table><tbody><tr><td><\/td><td>Liquidity Provider (Raw Spread)<\/td><td>Trading Platform\u2019s A-Book Volume Fee<\/td><td>Broker\u2019s<br>Markup<br>(pips)<\/td><td>Retail Spread<br>(pips)<\/td><td>Retail Spread (USD)<\/td><td>Income on each lot (pips)<\/td><td>Income on each lot (USD)<\/td><\/tr><tr><td>EUR\/USD<\/td><td>0.1<\/td><td>0.2<\/td><td>1<\/td><td>1.3<\/td><td>$1.30<\/td><td>1<\/td><td>$1<\/td><\/tr><tr><td>A-Book Transaction Fee<\/td><td>0.3<\/td><td><\/td><td><\/td><td><\/td><td><\/td><td><\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n<p>And for every micro lot, the broker will make&nbsp;<strong>$0.10<\/strong>!<\/p>\n\n\n\n<figure class=\"wp-block-table is-style-regular\"><table><tbody><tr><td><\/td><td>Liquidity Provider (Raw Spread)<\/td><td>Trading Platform\u2019s A-Book Volume Fee<\/td><td>Broker\u2019s<br>Markup<br>(pips)<\/td><td>Retail Spread<br>(pips)<\/td><td>Retail Spread (USD)<\/td><td>Income on each lot (pips)<\/td><td>Income on each lot (USD)<\/td><\/tr><tr><td>EUR\/USD<\/td><td>0.1<\/td><td>0.2<\/td><td>1<\/td><td>1.3<\/td><td>$0.13<\/td><td>1<\/td><td>$0.10<\/td><\/tr><tr><td>A-Book Transaction Fee<\/td><td>0.3<\/td><td><\/td><td><\/td><td><\/td><td><\/td><td><\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n<p>As you can see, an A-Book broker barely makes money offering mini lots, only making about&nbsp;<strong>$1 per mini lot<\/strong>&nbsp;(10,000 units).<\/p>\n\n\n\n<p>But the money is even punier when offering micro lots, where the broker only makes&nbsp;<strong>10 cents<\/strong>!<\/p>\n\n\n\n<p>Now you can see how difficult it is to operate as strictly an A-Book broker if you have customers who trade small position sizes.<\/p>\n\n\n\n<p>Here\u2019s how the broker\u2019s income would look like with the growing number of customers compared to a different amount of mini lots (10,000 units) traded.<\/p>\n\n\n\n<p>The numbers below show the broker\u2019s income after paying the institutional spread and transaction fees.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">Monthly A-Book Revenue Example<\/h3>\n\n\n\n<p>Based on the numbers above, here\u2019s what an A-Book would make per month if its customers traded mini lots.<\/p>\n\n\n\n<figure class=\"wp-block-table is-style-regular\"><table><tbody><tr><td><strong>Number of Customers<\/strong><\/td><td><strong>Number of mini lots per month per customer<\/strong><\/td><\/tr><tr><td>5<\/td><td>10<\/td><td>30<\/td><\/tr><tr><td>100<\/td><td>$500<\/td><td>$1,000<\/td><td>$3,000<\/td><\/tr><tr><td>500<\/td><td>$2,500<\/td><td>$5,000<\/td><td>$15,000<\/td><\/tr><tr><td>1,000<\/td><td>$5,000<\/td><td>$10,000<\/td><td>$30,000<\/td><\/tr><tr><td>5,000<\/td><td>$25,000<\/td><td>$50,000<\/td><td>$150,000<\/td><\/tr><tr><td>10,000<\/td><td>$50,000<\/td><td>$100,000<\/td><td>$300,000<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n<h3 class=\"wp-block-heading\">Yearly A-Book Revenue Example<\/h3>\n\n\n\n<p>Based on the numbers above, here\u2019s what an A-Book would make after 12 months if its customers traded mini lots.<\/p>\n\n\n\n<figure class=\"wp-block-table is-style-regular\"><table><tbody><tr><td><strong>Number of Customers<\/strong><\/td><td><strong>Number of mini lots per month per customer<\/strong><\/td><\/tr><tr><td>5<\/td><td>10<\/td><td>30<\/td><\/tr><tr><td>100<\/td><td>$5,000<\/td><td>$12,000<\/td><td>$30,000<\/td><\/tr><tr><td>500<\/td><td>$30,000<\/td><td>$60,000<\/td><td>$150,000<\/td><\/tr><tr><td>1,000<\/td><td>$60,000<\/td><td>$120,000<\/td><td>$360,000<\/td><\/tr><tr><td>5,000<\/td><td>$300,000<\/td><td>$600,000<\/td><td>$1,500,000<\/td><\/tr><tr><td>10,000<\/td><td>$600,000<\/td><td>$1,200,000<\/td><td>$3,600,000<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n<p>As you can see, it\u2019s hard for A-Book brokers to make money unless they have A LOT of customers who trade FREQUENTLY (preferably at large sizes).<\/p>\n\n\n\n<p>A-Book brokers are motivated to have profitable traders because profitable traders tend to&nbsp;<strong>increase either their trading size and\/or volume<\/strong>&nbsp;which means more revenue for the broker.<\/p>\n\n\n\n<p>Advocates of A-Book brokers argue that the A-Book execution model is \u201cbetter\u201d for customers versus B-Book since the broker is not directly profiting from customers losing money on the trade. This means that a broker\u2019s interests are more aligned with their customers.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>Not sure you noticed in the previous two examples in the\u00a0previous lesson, but the A-Book broker did\u00a0NOT\u00a0make any money. The examples were shown this way to keep the focus on how the broker offloaded its market risk. So&nbsp;how do A-Book brokers make money? Unlike a\u00a0B-Book broker, an A-Book broker does NOT make money when its [&hellip;]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[768],"tags":[],"_links":{"self":[{"href":"https:\/\/mudassirbackup.infinitycodestudio.com\/index.php\/wp-json\/wp\/v2\/posts\/9489"}],"collection":[{"href":"https:\/\/mudassirbackup.infinitycodestudio.com\/index.php\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/mudassirbackup.infinitycodestudio.com\/index.php\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/mudassirbackup.infinitycodestudio.com\/index.php\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/mudassirbackup.infinitycodestudio.com\/index.php\/wp-json\/wp\/v2\/comments?post=9489"}],"version-history":[{"count":0,"href":"https:\/\/mudassirbackup.infinitycodestudio.com\/index.php\/wp-json\/wp\/v2\/posts\/9489\/revisions"}],"wp:attachment":[{"href":"https:\/\/mudassirbackup.infinitycodestudio.com\/index.php\/wp-json\/wp\/v2\/media?parent=9489"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/mudassirbackup.infinitycodestudio.com\/index.php\/wp-json\/wp\/v2\/categories?post=9489"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/mudassirbackup.infinitycodestudio.com\/index.php\/wp-json\/wp\/v2\/tags?post=9489"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}