This article is for educational purposes only. Trading with leverage, margin, futures, or derivatives carries a high risk of rapid or total loss. This is not financial advice and should not be used to make trading decisions.
How Do Brokers Make Money On Leverage?
Most brokers earn fees when traders borrow leverage. This applies to leveraged products only and does not apply to spot trading or unleveraged investing.
Leverage increases broker revenue because the fees scale with position size, even when traders lose. It does not mean leverage is profitable for the trader.
But how do brokers make money on leverage exactly and how much do they make on each trade?
This breakdown is meant for traders who already understand basic order types and spot trading. It explains how brokers price leverage and why the costs are often underestimated.
The info box below is a quick summary of the most important points of this article. To get an in-depth understanding I recommend that you read through the whole guide.
Key takeaway
- The three main ways that brokers make money on leverage are trading fees, spreads, and overnight fees (management fees).
- A 5× increase in buying power also means a 5× increase in fees and potential losses, even if the market only moves a fraction of a percent. The overnight fee is an interest payment charged by brokers for providing you with margin and it is similar to an interest payment on a mortgage.
- The main benefit to brokers is larger fees. The largest risk to traders is that costs compound fast in volatile markets, especially when trades are opened and closed frequently.
- Market Maker brokers can profit from trader losses because they hold the opposite side. This setup increases conflicts of interest, which is why experienced traders often choose non-MM models for leverage.
The three main ways brokers make money with leverage
Brokers have three main ways of making extra money while offering leverage to traders.
- Trading fee = Fee charged to open and close trades.
- Spread = Spread cost between the bid and ask price.
- Management fee = Interest payment charged each day for keeping a leveraged position open overnight.
Trading fees
It is common knowledge that most trading platforms make the bulk of their income from trading commissions and spreads but in the case of a broker, these costs are increased.
Amplified costs are one reason why traders with small accounts are rarely profitable when using high ratios. Fees scale, and losses scale with them.
Keep in mind that the actual percentage of spread distance does not change, only the position size.
Since leverage gives you the ability to trade with a larger position size, the fee that goes into opening and closing the position is increased.
For example, if you deposit $1500 into your stock broker account and buy stocks for all your money and the commission is 0.15% you would pay a flat fee of $2,25.
Even moderate leverage can multiply fees to a level that wipes out the gains of otherwise good trades.
Spread
Spread is the difference between the bid and the ask price in the order book.
This is a standard fee that most forex brokers charge their clients for opening and closing trades and is often used instead of a flat percentage fee.
A standard spread cost is somewhere between 0.2 pips to 20 pips depending on how liquid the currency pair is.
The wider the spread, the higher the cost.
Brokers make money more money with spread costs when credit is added since the position size is typically larger than in a spot market trade.
Let’s say that you trade forex with leverage and open a standard lot worth $100,000 at a spread of 2 pips.
This would cost you $20. ($100,000 x 0,0002 = $20)
Imagine that you don’t add a multiplier to that mix and reduce the position size by 100 times.
Your spread cost would suddenly drop to $0,20.
Management fee (overnight fee)
The management fee is a flat interest payment brokers charge for keeping positions open overnight.
It has the same function as a monthly mortgage payment with the difference that it is charged every day at midnight for positions that roll over to the next day.
This is very common in crypto trading and most brokers who offer leveraged products such as futures, options, or other derivatives charge this commission.
The management fee is typically between 0.03% and 0.06% depending on the trading platform.
You can avoid paying this commission by closing out all your positions before the end of the day.
Only open positions will be charged the management fee.
To learn more about of derivatives work in crypto, see our full guide: What are crypto derivatives?
These are the types of brokers you should know about
The most common type of brokers are:
- STP = Straight Through Processing
- MM = Market Maker
- ECN = Electronic Communication Network
- DMA = Direct Market Access
Each type has its features when it comes to how they provide liquidity and how they match trades.
The broker you choose will either take the other side of your trade, which is the case for the Market Maker brokers.
Or, they will hire a liquidity provider that will take on all the risk.
STP, ECN, and DMA brokers do not assume the risk on their own, and in trading terms, it’s called that they don’t have their own “dealing desk”.
Only MM brokers have a dealing desk that handles all the trades in-house.
Why do brokers provide leverage to traders?
Brokers and trading platforms that provide leverage do so simply to earn more money.
These fees increase which is direct revenue, losses tend to be larger (which benefits MM brokers), more markets are offered so their client base is larger, and more flexible trading is offered through short selling/hedging.
The overall activity on the trading platform is also increased because the way brokers market leverage is for day traders mostly.
High-frequency trading with leverage is one of the fastest ways to burn an account. Brokers earn more because fees compound. Traders rarely outperform that compounding cost unless they already have long-term, tested, and disciplined systems.
Do brokers ever lose money?
Yes, sometimes they do, but only Market Maker brokers.
Here is why.
Only one type of broker called a Market Maker broker will lose from providing leverage to its clients and this happens when traders profit.
Since Market Maker brokers take the other side of the trader’s position they are at risk of losing money every time a trader enters the market.
Suppose a trader enters the FX market with a standard lot of $100,000 and makes a +1,20% gain.
This equals a profit of $1200 for that trader and a $1200 loss for the MM broker.
This is the only time that a broker would ever lose money.
How much do brokers charge their traders to borrow money?
Some brokers will sometimes charge a management fee which acts much like an interest payment on a car loan or a mortgage.
The management fee typically costs anywhere between 0.03% – 0.06%.
This fee is charged at the end of the day for all positions that are carried over to the next trading day.
Since a multiplier is borrowed money it makes only sense for the broker to charge you a small percentage as interest for borrowing their capital.
Most brokers do not provide their own liquidity and are more or less forced to charge their traders a management fee since they are in turn charged by their own liquidity providers.
Other than this direct fee, there is no other fee that brokers charge for leverage.
Anton Palovaara
This article is published under Leverage.Trading’s Risk-First Education Framework, an independent learning system built to help traders quantify and manage risk before trading.
