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The Hidden Costs of Trading

The Hidden Costs of TradingTraders often look at their bottom line profit and loss on their account to gauge their performance, but what’s usually overlooked are the hidden costs of trading such as commissions, spread, interest, or negative carry. Costs associated with education, signal services, and even missed opportunities should be factored in as well.

Transactions costs

First off, the most obvious costs that add up and affect your account balance are the transactions costs. These cover commissions, spread, and interest. With stocks, brokers make profits by charging commissions for executing trades. After all, the broker executes those trades on behalf of the trader or takes the opposite position so they need to charge for that service either through a fixed amount per position or a percentage of the trade. These charges are made when you enter the trade and also when you close the trade.

In forex trading, while most brokers offer commission-free trading, they make profits through the bid-ask spread. If you look at order boards or rates tables, you will notice two prices being quoted, one of which indicates the price at which you can buy the currency pair and the other showing the price at which you can sell. The spread is the difference between these bid and ask prices but this cost is usually charged on only one side of the forex transaction.

These spreads vary across currency pairs, depending on your broker. In addition, the spread can widen during volatile market times, although some brokers promise fixed spreads.

Another cost that can be incurred while trading is that of interest. In forex, this can be calculated using the difference in the benchmark central bank rates of the currencies you are trading. For instance, if the Reserve Bank of Australia offers a 1.75% interest rate and the Bank of Canada has a 0.50% benchmark rate, going long AUD/CAD can give you an additional 1.25% carry on your position while shorting the pair can yield a negative carry of 1.25%. This carry trade affects your profit or loss materially if you keep the position open for more than a day.

With CFD (contract-for-difference) trading, you also incur costs for holding positions open overnight. These costs can also be positive or negative, depending on which side of the trade you are on. Holding costs for trading index CFDs are based on the underlying interbank rate of the index and share CFD holding costs are based on the interbank rate of the share currency. Holding rates for commodities and treasuries are based on the inferred rates built into the futures contracts from which the CFDs are derived.

Taxes might also be applicable depending on your jurisdiction and financial industry laws. For some, capital gains taxes must be paid and subtracted from your overall account balance, counting these as additional trading fees. Other monetary costs that must be accounted for are the funds you spent on your trading equipment, internet connection, office setup, and overhead such as electricity.

Subscription costs

Traders who have been in the game for quite some time but would like to improve their skills or profitability may opt to subscribe to premium services. These include signal services, expert analysis, or any form of information that isn’t publicly and freely available. Getting the services of a trading coach or mentor also counts as an additional cost, and so are the management fees associated with leaving your funds with portfolio managers.

When it comes to subscribing to these services, be wary of products that are marketed to seem more profitable or useful than they actually are. Make sure you look at the track record or back test results of a trade signal service or see if there are any alternatives that can allow you to save on costs. After all, monthly fees and upgrades can add up over time and you need to rake in more profits just to be able to make up for these additional costs.

In addition, it is in these services that fraudulent activity can arise so don’t forget to do the proper research by reading online reviews or testimonials before subscribing to any. Keep in mind that falling prey to a scam would mean even larger costs for your account, burning a much deeper hole in your pocket than you started with, so there’s no harm in doing due diligence.

Opportunity costs

On the non-monetary side of things, failing to catch valid trade setups can also be counted as opportunity costs. After all, traders typically lock in a significant amount of capital in their account so failing to catch those setups represents lost profit opportunities, not to mention the time you spend watching the markets and not capitalizing on valid trades is wasted.

While these types of costs don’t wind up hurting your account balance, they could hurt your trading psychology, which might have a longer-term impact on your performance. Not having enough confidence in your strategy and hesitating to jump in those setups that fit your framework could prevent you from maximizing your system’s profitability, further weighing on your confidence.

This can be apparent for traders who are in a losing streak and refrain from taking the succeeding setups that they spot. This behavior could keep them in a slump for much longer, as they fall victim to the recency bias trap. Soon enough, they might notice that they have missed so many trade opportunities that they try to make up for it by overtrading, which may be as damaging.

To combat this, try to record your taken and missed setups in a trading journal. List down the reasons why you decided to take a trade or why you decided against it and how it all turned out. At the end of every quarter or year, look back on the missed opportunities to see if you are losing out on setups that could’ve yielded profits for your account and remind yourself to be confident in your strategy.

Risk warning: Forward Rate Agreements, Options and CFDs (OTC Trading) are leveraged products that carry a substantial risk of loss up to your invested capital and may not be suitable for everyone. Please ensure that you understand fully the risks involved and do not invest money you cannot afford to lose. Our group of companies through its subsidiaries is licensed by the Cyprus Securities & Exchange Commission (Easy Forex Trading Ltd- CySEC, License Number 079/07), which has been passported in the European Union through the MiFID Directive and in Australia by ASIC (Easy Markets Pty Ltd -AFS license No. 246566).

Sources:

http://www.earnforex.com/articles/forex-trading-understanding-commissions-spreads-and-trading-costs/

http://www.babypips.com/blogs/pipsychology/forex-missed-trades.html

http://www.quickmba.com/finance/invest/tradecost/

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