When you start currency trading, you are told by every forex broker that there are no commissions involved in forex trading. New traders take their brokers words as true and most think that the cost of trading is minimal.
Forex brokers are also called FCMs (Futures Commission Merchants) sometimes. They make profits through the bid/offer spread they charge their clients for each currency pair. This bid/offer spread is your trading cost and profit for your broker.
Lets take a practical example to make it clear how trading costs can effect your trading. Bid/offer spreads are usually overlooked by retail traders as the price they have to pay for trading. So lets calculate what your cost of trading can be annually.
Suppose you are day trading. 5 times every day, taking away the weekends, when you cant trade, there are 250 trading days for you.
As a day trader, you will open and close each trading position before the end of each trading day. That means each position is being traded 2 times, once when you open the trade and once when you close the trade.
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.
Your Annual Turnover should be; (5) (250) (2)(200,000)= $500 Million. Isnt it huge! Now lets calculate how much FCM will make and what your spread cost is. Spread Cost= (Annual Turnover) (spread)/2.
Suppose further, the bid/offer spread charged by the broker is 3 pips. 3 Pips Spread Cost= (500M) (0.0003)/2= $75,000.
Suppose the bid/ask spread offered by the broker is only 2 pips. 2 Pips Spread Cost= (500M) (0.0002)/2= $50,000.
The cost of trading with a 3 pips spread versus a 2 pips is $25,000. This is 50% of your account equity. You can see yourself that a 1 pip difference can result in $25,000 more of trading costs.
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.
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