| One of the website visitors had asked me to explain how a Forex broker can pay out million-dollar profits to successful traders. Unless the broker is a casino (a bucket-shop) — in that case the answer is obvious — the scheme is not that apparent to a layman. To get this clear, we need to look at how profit is made in retail Forex. A trader (let's call her Trader Ann) deposits $10,000 margin into her trading account. This money is usually kept in the broker's bank account or in a special segregated account. Next, Trader Ann buys 5 lots of EUR/USD at 1.0700 with 1:100 leverage. What happens from the trader's point of view, is that $5,350 (1.07×5,000) margin is taken by the broker to hold the position. At the same time, some floating profit/loss associated with the position appears in the account. There are two possibilities of what happens from the broker's point of view: - If the broker acts like a market maker, it offsets the trade with an equal position with another market maker or, rarely, another trader.
- If the broker acts like an ECN, it matches the trade to another trade inside its network.
In case of a market maker, the broker now has two positions in its books (considering 1 pip spread marup): - SELL 5 lots EUR/USD @ 1.0700 to Trader Ann
- BUY 5 lots EUR/USD @ 1.0699 from another MM
When EUR/USD rate reaches 1.2000 and Trader Ann decides to close her EUR/USD Buy of 5 lots. That SELL position ends up in a loss of $650,000. The BUY trade ends up in a profit of $650,500. The market maker collects its profit from a bank, another broker or whoever it had bought the 5 lots from. It pays out the trader's due ($650,000) and keeps the difference to itself ($500). The trade can go through several market makers before it is matched with one or more actual trades. The broker gets the money from the next MM it dealt with but the eventual loser can be several layers apart. In case of an ECN, the broker has no positions in its books — the trades are held by two matched traders. Let's call the second trader Bob (in reality, Bob could be some transnational corporation): - Trader Ann: BUY 5 lots EUR/USD @ 1.0700
- Trader Bob: SELL 5 lots EUR/USD @ 1.0700
When EUR/USD goes to 1.2000 and Trader Ann closes her position, Trader Bob owes $650,000 to her. Since there was no stop-out of a trade during the period, obviously, Trader Bob has enough free margin in his broker's account to cover the loss. Trader Ann receives her winnings from Trader Bob via their brokers. To conclude, in both cases, brokers pay out huge winnings to traders using the money lost by other traders. In case of an ECN, the traders are matched more or less directly. In case of a market maker, there can be several layers between the winning and the losing trader. | 
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