Penny Wise, Profit Foolish - Why Trading Costs Matter
Welcome to the world of forex trading, where every pip counts!
While it may seem like forex is a no-cost, low risk venture for making money, there are hidden costs and risks that can take a bite out of your profits if you do not pay attention.
You have probably heard of the "latte factor" - the idea that small daily expenses, like buying a latte, can add up over time to a significant amount of money. Well, trading costs in forex are like the latte factor on steroids. Every spread, every commission, every swap fee - they all add up to a substantial amount of money in the long run.
Do not be fooled by the promise of unlimited profit potential; forex is rife with hidden costs, and it is important to understand them before committing your capital to any trade.
Let this article be your guide as we help you become better informed about the not-so-obvious trading costs associated with forex so that you can maximise your earnings.
Does a Spread Really Matter?
Have you ever heard the saying "a penny saved is a penny earned"? Well, in forex trading, it is more like "a pip saved is a pip earned". That is because even the tiniest difference in the buy and sell price, aka the spread, can eat away at your profits faster than a swarm of hungry locusts.
The impact of spread on trade profitability is often overlooked. Going from a 2-pip spread to a 0.8-pip spread does not sound like much. However, depending on your trading style, it might have an impact in a long-term perspective.
Now, let's take a closer look at how spreads can affect your profits.Imagine that there are two traders who both make approximately 20 deals a day, their past return on equity is 20%, and the deal leverage is 100:1 (with Global Prime you can trade with a maximum of 200:1 leverage or 30:1 for our retail ASIC clients). The only difference is the spread (2 pips for Trader A and 0.8 for Trader B).Number of trades per year = 20 x 250 x 2 = 10,000Assumption: 250 trading days per year, each deal: 1 enter & 1 exitAnnual Trading Volume = 10,000 x 100 x $1,000 = $1 billionNumber of trades x leverage x account equityThenTrader A: the spread is 2 pips.Absolute Spread Cost = trading vol x spread 2 = ($1 billion x 0.0002)/2 = $100,000Trader B: the spread is 0.8 pips.Absolute Spread Cost = trading vol x spread 0.8 = ($1 billion x 0.00008)/2 = $40,000It means that Trader B who trades with a spread of 0.8 pips can make $100,000 per year, which is $60,000 more ($100,000 - $40,000 = $60,000) than Trader A who trades with a spread of 2 pips.Trader A incurs not only the additional expenses but also the opportunity costs associated with the unavailability of the funds. The funds could have been channelled towards savings, investments, mortgage payments, car loans, or other financial obligations. Moreover, the potential for compound growth on those funds over time exacerbates the opportunity cost implications.
Please note that this is just an example and does not reflect actual market conditions or trading results, which can be influenced by a variety of factors such as market volatility, economic events, and geopolitical risks, among others.
However, if you choose the right broker, who offers competitive spreads, it can have a significant impact on your profitability. By reducing transaction costs, increasing trading frequency, improving risk management, and providing better trade execution, it can help you achieve your financial goals in no time.
At Global Prime, it is our mission to democratise access to global markets. Therefore, we offer our clients spreads from as low as 0.0 pips, and minimum commissions. Discover the wide range of opportunities by visiting our Account Types page.
We encourage you to always consider the bid-ask price when choosing a broker or currency pair to trade, as it can have a significant impact on the bottom line.
But wait, there is more...
By keeping your trading costs low, you are able to save more of your profits and limit potential losses from trades gone awry. This gives you greater flexibility when it comes to making decisions about which trades to enter or exit from. Here are a few other things to consider:
When you are trading forex, you might experience slippage. No, not the kind you get when you trip over your cat and fall on your face. This kind of slippage happens when the market moves so fast that your trade does not get executed at the price you wanted or your order size is too big it eats up the orderbook.
To mitigate the risk of slippage, traders can use limit orders, which allow them to specify the price at which they want to enter or exit a trade. This way, even if the market moves quickly, the trade will only be executed at the specified price.
Holding a position overnight can result in swap fees. It is like your apartment rental fee for holding a currency, except you do not get to live in it. Instead, you are just holding onto it, hoping it will appreciate in value.
In forex, currencies are traded in pairs, and each currency has its interest rate. The swap fee is the cost of borrowing one currency to buy another and is calculated based on the interest rate differential between the two currencies.
There are a few ways to save on swap costs:
- Choose the right currency pair: The swap rates vary depending on the currency pair you are trading. Some currency pairs have a higher swap rate than others, so it is important to choose the right currency pair that offers lower swap rates.
- Avoid holding positions overnight: If you do not want to pay swap fees, you can close your positions before the end of the trading day.
- Use hedging strategies: Hedging strategies can help reduce the risk of holding positions overnight and minimise the impact of swap fees.
Always remember to do your research, choose the right broker, and understand the costs involved in forex trading.
Commission is a fee charged by a broker for executing your trades. The commission cost can vary depending on the broker and the type of account you have. Typically, it is lower for high-volume traders. Some brokers also offer commission-free accounts, but these often have wider spreads.
At Global Prime, we aim to give our customer razor-thin spreads no matter what. We help traders maximise their profits by reducing their exposure to risk in volatile markets and trading costs while also providing them with greater control over their investments.
Forex trading costs can also include taxes and other government charges. Depending on your country’s laws and regulations, you may be required to pay taxes on forex profits. Make sure you understand what these taxes are before taking a trade.
Overall, it is important to be aware of the different types of trading costs, such as spreads, slippage, swap fees, commissions, and government charges, and factor them into your trading strategy. So, keep an eye on them, and remember, a penny saved is a penny earned (or not lost).
Maximising your profits by choosing the right broker
Are you trying to develop a well-diversified portfolio, but do not want to pay an arm and a leg for it? Fear not! Choosing the right broker and account type that is tailored for your needs can help reduce costs when making trades.
- Look for a broker with tight spreads - The tighter the spread, the lower your execution costs. That's where Global Prime comes in - we offer some of the tightest spreads in the market.
- Check the commission rates – Depending on your account type, some brokers charge a commission on top of the spread. Make sure you check the rates and pick an account that meets your requirements. At GP, our commissions are only $3.5 per side on FX and Metals, our other assets have $0 commissions!
- Look for fast and reliable execution - Low-cost execution is great, but it is not worth it if your trades are not executed quickly and reliably. At Global Prime, we provide fast and stable trading platforms to ensure your trades are executed without delay. With a variety of world-class tools, you will have an edge even over professionals.
Choosing the right broker is a lot like picking the perfect avocado - it requires a little bit of skill and a little bit of luck. Here are some tips to help you find your perfect trading partner:
With the right broker you can increase your probability of success, and by doing your homework you will be able to save on fees - leaving more money for reaching those investing goals. So go ahead and crack open the books: your pockets (and financial future) will thank you!
Sign up for Global Prime live account and experience our low-cost trading experience today.
We cannot wait to help you unleash your full potential! Happy trading!