The Hidden Cost Of Trading
I mean that literally. To every trader out there that thinks you place your trades for free, allow me to disabuse you of that notion immediately! IT COSTS MONEY TO TRADE. And no, I’m not talking about your losses.
When you place a trade, ANY TRADE, whether it was a mistake, a bad trade, or a good trade, your broker will either charge you a COMMISSION and/or a SPREAD. There is no avoiding this. You have to pay to play.
So why am I telling you this? I am telling you this because most traders negate or neglect to acknowledge this cost in their trading results, especially when they are back-testing.
Whenever you back-test a strategy or system, it is highly likely that you only record whether a trade was a win or a loss and how much you made or lost, but not many traders record the cost of the actual trade.
This affects long-term traders to a lesser extent but let’s face it, most traders starting out won’t have the capital or patience to trade a $100 account (which is only possible in Forex by the way, other markets don’t have the leverage that enables you to trade $100 properly) once a month.
So to the traders that place multiple trades a week (and even more especially to those who trade multiple times a day), you need to factor in those costs!
IF YOU DON’T, you might fall victim to them. Your trading costs could be the difference between a break-even strategy and a losing one. Equally, and more painfully, this could be the difference between your strategy making a 5% return instead of the 10% return you expected.
Spread vs. Commission
I think most traders will agree that opting to pay commission is way better (cheaper) than paying for the spread when trading Forex. That, I think, is mostly because in Forex you don’t have a fixed spread, which is common when trading stocks The spread is dynamic i.e. it’s always changing.
That can work in your broker’s favor if there is volatility and your entry is executed halfway to your Take-Profit (TP), your broker can coin it on the spread.
When you choose to pay commission instead, most brokers will give you a better spread (less spread) than their clients who don’t pay them a commission. You may think that this practice is unfair or shady? But at the end of the day, it’s just business and everyone is trying to make a buck.
Rather pay a fixed commission than a dynamic spread, and you will be paying less hidden costs in the long run.
That’s the thing about these costs. They are so small and minuscule that it is easy to think they don’t matter, but OVER TIME they add up. Small costs can add up to amounts that resemble a drawdown if you’re not careful because you are charged for losing trades as well as winning trades.
Overnight RATE (Swap)
Swap is another hidden cost that I remembered when looking at my statement the other day. WHAT IS IT?
“Overnight rate is the rate at which a depository institution (generally banks) lends or borrows funds with another depository institution in the overnight market.” – Investopedia
Basically, banks and financial institutions (your broker) have to meet “reserve requirements” which means they must have a certain amount of money on them at all times.
Why? Because people deposit and withdraw money all day long and at no point should a financial institution not have the money to pay someone who is trying to withdraw what is rightfully theirs or else… the cuffs are on buddy. Therefore brokers sometimes borrow money from other institutions at a particular interest at the end of the day if they don’t have enough.
That’s something they also charge to you if you ever leave your positions open overnight. This cost will affect (or sometimes work in favor of) longer-term traders. Every day they have that position open, they will be paying a fee or swap on it. That is a cost that can quickly erode profits.
If it were a snake, it would’ve bitten me
These two costs combined can eat up at the very least 10% of your profits, easily. Imagine making $1 million, then realizing you’ve actually netted 900K because of trading costs AND THEN you still have to pay tax on that amount.
To put it into perspective, let’s say you lost $1 million. Some of you might think your life would be over, but it wouldn’t be and congratulations on having $1 million to lose in the first place. But if you lost $1 million, you would’ve actually lost $1,1 Million because of the fees you paid to trade.
These costs may not seem like a lot after one trade or ten trades. But after 100 trades? How about 1000 trades? Unless you’re planning to make your trading fortune in only ten trades (Good luck), these are the costs you are going to have to consider as well. Even in your testing phase!
If you took away 10% (could easily be more) of your profits, does your system still make money? Even then, does your system make ENOUGH money?
This could be a key difference between winning and losing. Not paying attention to how much it costs you to trade, and if your profits sufficiently cover those costs? Think about those things.
Now that you know of these hidden costs, you can acknowledge the importance of brokers that prioritize us traders and offer reasonable trading costs. Here are some reputable options you should consider:
Don’t bet the farm.
Don’t lose your shirt.
Cut the L.
Keep the W.