When you open a currency trading account, you are told by your forex broker that there are no commissions involved in forex trading. New traders take their brokers word as true. Most think that the cost of trading is minimal.
Forex brokers also called FCMs (Futures Commission Merchants) make profits through the bid-ask spread they offer to their clients for each currency pair. This bid-ask spread is the trading cost for you and the profit for your FCM.
Lets do a simple calculation. Spreads are usually overlooked by the individual traders as the price they pay for trading. So lets calculate your cost of trading.
Suppose you are a day trader. You trade 5 times a day. Taking away the weekends, when you cant trade, there are 250 trading days.
As a day trader, you open and close your position before the end of the day. That means each position is traded 2 times.
Suppose; your account size is $ 50,000. You are using a leverage of only 4. So this $50,000 will control (50,000) (4) = $200,000.
Annual Turnover = (5) (250) (2) (200,000) = $500 Million. You can see the annual turnover of your trading is huge! Now lets calculate how much your broker will make and what your trading cost is based on your spread cost. Spread Cost= (Annual Turnover) (spread)/2.
Suppose the spread offered by the broker is 3 pips. 3 Pips Spread Cost= (500M) (0.0003)/2= $75,000.
Suppose, the spread offered by the broker is only 2 pips. 2 Pip Spread Cost= (500M) (0.0002)/2= $50,000.
You can see now, the cost of trading with a 3 pips spread versus a 2 pips is $25,000. Huge for you, this is 50% of your account equity. You see now that a 1 pip difference can result in $25,000 more as trading cost for you.
You will need to make a profit of $75,000 simply to break even with a 3 pips spread. Trading costs are one of the primary reasons most active traders fail in the long run.
Forex brokers also called FCMs (Futures Commission Merchants) make profits through the bid-ask spread they offer to their clients for each currency pair. This bid-ask spread is the trading cost for you and the profit for your FCM.
Lets do a simple calculation. Spreads are usually overlooked by the individual traders as the price they pay for trading. So lets calculate your cost of trading.
Suppose you are a day trader. You trade 5 times a day. Taking away the weekends, when you cant trade, there are 250 trading days.
As a day trader, you open and close your position before the end of the day. That means each position is traded 2 times.
Suppose; your account size is $ 50,000. You are using a leverage of only 4. So this $50,000 will control (50,000) (4) = $200,000.
Annual Turnover = (5) (250) (2) (200,000) = $500 Million. You can see the annual turnover of your trading is huge! Now lets calculate how much your broker will make and what your trading cost is based on your spread cost. Spread Cost= (Annual Turnover) (spread)/2.
Suppose the spread offered by the broker is 3 pips. 3 Pips Spread Cost= (500M) (0.0003)/2= $75,000.
Suppose, the spread offered by the broker is only 2 pips. 2 Pip Spread Cost= (500M) (0.0002)/2= $50,000.
You can see now, the cost of trading with a 3 pips spread versus a 2 pips is $25,000. Huge for you, this is 50% of your account equity. You see now that a 1 pip difference can result in $25,000 more as trading cost for you.
You will need to make a profit of $75,000 simply to break even with a 3 pips spread. Trading costs are one of the primary reasons most active traders fail in the long run.
About the Author:
Mr. Ahmad Hassam has done Masters from Harvard University. He is interested in day trading and swing trading stocks and currencies. Know These Forex Broker Games. Learn Forex Trading.
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