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Costs Associated With Forex Trading

Costs in ForexMoney management is very important while trading Forex, hence, it is important to factor in trading costs in one’s trading. Higher costs of trading could alter traders’ trading results leading to reduced profits or overall losses. It is particularly important to check Forex trading costs while choosing a broker since various brokers have varying costs depending on account types offered. Below are the various costs associated with Forex trading;

Spread;

This is the most common type of cost in Forex and is usually the difference between the bid and ask price provided by your broker. The bid price is the price the broker is willing to charge you to buy a particular currency pair. The ask price (also referred to as the offer) is the price the broker is willing to sell that pair.

Higher spreads are often seen in low volume traded currency pairs while more traded currency pairs such as the majors exhibit lower spreads.

There are two types of spreads depending on the type of broker; Dealing or Non-Dealing broker.

Fixed Spreads;

Fixed spreads remain constant regardless of the market conditions and are offered by Dealing or market making brokers. Since the spread does not vary; traders who prefer want to make calculations of their trading costs in advance will use dealing brokers.

Fixed spreads have their disadvantages during more volatile market conditions when prices are moving rapidly leading to trade requotes and slippage.

Variable Spreads;

Non-Dealing brokers offer variable spreads which tighten or widen depending on the market’s volatility. Normal trading hours tend to show tighter spreads while periods of high impact news or night markets exhibit wider spreads.

Non-Dealing brokers often get their prices from several liquidity providers and hence tend to offer relatively favorable spreads than Dealing brokers or Market Makers. Additionally, due to the changing nature of variable spread; requotes are rare.

Calculating the Spread;

Spread

As stated earlier, the spread is the difference between the Bid and Ask price given by your broker.

Spread = 1.44439 - 1.44423 = 1.6 pips.

Once obtained, we need to factor in the value of one pip and the number of lots traded as below;

Spread; 1.6 pips X
Value per pip; $10 (per standard contract) X
Number of lots; 5 lots =
Total Spread cost; $80

Slippage;

Most traders have experienced situations where their orders were filled higher or lower than the price during placement of the order. Although most traders will blame the brokers for such situations; slippage in very volatile market conditions may be unavoidable. Trades from buyers have to be matched to those of sellers by the broker, hence, in very volatile or less active market conditions, the broker has to offer the next available price leading to slippage.

To reduce the slippage issue, traders should open their accounts with Non-Dealing brokers having multiple liquidity providers which allows a larger pool of prices. They can also choose to trade during normal market hours and avoid volatile and very slow moving markets. Automated system traders should also ensure their systems have a maximum slippage parameter which they can select so their system may not execute trades during undesired slippage levels.

Since the number of trade sizes must match that of sellers at a particular price for zero slippage to occur; currency pairs with more market participants such as EURUSD and USDJPY will have less slippage.

Slippage examples;

Negative slippage; An order to buy EURUSD at 1.4500 is placed, however; price quickly moves to 1.4505 before the trade is executed. This leads to a -5 pips slippage (1.4505 - 1.4500).

Positive slippage; An order to buy EURUSD at 1.4500 is placed, however; price quickly moves down to 1.4595 before the trade is executed by the broker. This will lead to execution at 1.4595 leading to a +5 slippage (1.4500 - 1.4595). Hence, slippage may also act in favor of the trader.

From the above examples; you can notice that obtaining zero slippage is highly influenced by the difference in time of placing an order and execution. Price can change rapidly in seconds, therefore, brokers who offer high execution speeds (such as real ECN brokers) will help reduce slippage. When using a VPS (Virtual Private Server), it is also important to choose one closer to your broker’s server to increase trade execution speed.

Commission;

Just like the spread, commissions are deducted at the opening of the trade by your broker. Different brokers will have different commission structures but the main ones are;

Fixed Commissions; In this structure, the broker will charge the same amount of commission for all trades (depending on the traded instrument) regardless of the trading size. For instance, the broker may charge $2 for every EURUSD trade placed regardless of the lot size.

Relative Commissions; The broker increases the commission for every trade (depending on the traded instrument) as the trading size increases. As an example, the broker may charge $10 for every lot traded (10 000 units) hence 5 lots would lead to $50 in commission.

It is important to note that some brokers may offer a trading account that charges both the commission and spread.

Swap/Rollover;

The swap can either be a trading cost or earned when trades are held overnight. The swap is a cost or charge when a position which involves a currency pair with negative interest, for instance EURAUD (the Eurozone has lower interest rates than Australia).

Swaps are not regarded much as a cost by most traders as they can also be earned and only affect traders who hold their trades overnight or for several days.

Other costs associated with Forex trading;

  • Costs of buying custom services such as analysis, custom indicators, Expert Advisors, signals, data feeds and commercial trading platforms.
  • Funding/deposit and withdrawal fees.
  • Account inactivity fees etc.

Conclusion;

Traders should understand that the broker runs its own business and charges various fees that may impact their trading results. Therefore, when choosing a brokerage, they should highly consider the type of trading costs they are going to incur. For instance; scalpers and news traders may prefer fixed spread accounts so as to factor in precise costs to be incurred. Happy trading!

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