Understand Your Hidden Trading Costs

10/15/2008 11:02 am EST

Focus: FOREX

John Jagerson

Co-Founder and Contributor, LearningMarkets.com

Trading costs in the forex can be a confusing topic. If you believe the marketing, then you would assume that costs are very low because there are no commissions. However, this is a little deceptive. For an average size, short-term trader, the forex can be one of the most expensive markets to trade when you consider the relationship the spread has with likely losses or gains.

If you could see a pool of average forex traders, you would notice some interesting commonalities. The average forex investor tends to trade fairly short term, and when market volatility goes up, they tend to trade more frequently. I think the two factors are actually related. Short-term traders usually have fairly tight profit targets and stop losses, therefore, if the average daily trading range increases, those limits and (more often) stop losses are hit much faster, which triggers the need to get into another trade.

If a trader is making a small amount relative to their margin in each trade, then the cost of trading or the spread between the bid and ask can start to really add up. An average short-term forex investor will trade roughly 20 times per month. During volatile markets that number increases to 25 trades per month. If you are an average trader, then you are probably paying a two-pip spread on the majors and "losing" 50 pips per month in trading costs alone.

To provide a little context to that 50 pip number; imagine that you are using $5,000 in margin and 100:1 leverage each time you trade. That means that you are paying $2,500 per month in costs. Of course, at PFX Global we traditionally tend to emphasize the benefits of long-term trading from a cost and potential gains perspective, but the real point behind this article is to start a discussion around the real costs of trading. Traders will often not consider them and dealers don't typically break them out on your statement. That means you have to plan for costs on your own before you implement a strategy.

By John Jagerson of PFXGlobal.com and LearningMarkets.com

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