The Hidden Costs of Currency Trading

With liquidity of more than 4 trillion in notional value per day, the global forex market allows traders to enter and exit will little upfront costs.   The majority of trading that takes place in the forex market is over the counter trading, where an investors takes prices from either a broker or dealer to enter and exit forex positions.  The majority who participate in the over the counter forex market are accustomed to spreads in currency pair which they are interested in trading.

When an investor trades in the forex market, they need to be concerned with two associated prices which are the bid which is the price you sell at and the ask which is the price you have to pay.  The difference between the two is what a trader is accustomed to as the spread.   The spread is the commission which the broker pockets and what the trader pays for the cost of doing business.  In futures trading of the currency market, a traders will not only pay away this spread but also a commission to his/her futures broker.

If a trader is not cognizant of the bid offer spread they can wind up picking a trading strategy that will be unsuccessful because they do not incorporate this cost into their strategy.    When a trader places a trade for example and there is a 3 pip spread associated to that trade there will be a 6 pip spread to that trade.  If your strategy is to move quickly in and out of the market trying to generate 5 pips per trade, you would need in this example to make 11 pips to be successful.

Let’s take a look at an example of a trade and the challenge that a trader can potentially deal with.  Let’s say each pip is worth USD $1.00.  3 pips in and 3 pips out totals $6.00 just in the spread price alone for a single trade.  What a trader needs to realize is that for he/she to make any money the trade needs to move 6 pips in their favor even to break even and 7 pips to make money.

The good news is that if you can find a broker whose typical spreads on the major pairs (EUR/USD, GBP/USD, USD/JPY etc.) are closer to 1 or 2 pips you can reduce your transaction costs considerably.   So, one of the most important aspects of trading Forex and to give yourself a fighting chance at continuous profitable trades is to find brokers that offer small reasonable spreads.

A trader must always keep in mind that trading is a business and just like any business there are associated transactional costs (in this case spreads) in doing business.  Therefore, anything that the trader can do to reduce these costs will increase his/her chances of improving their bottom line and potentially a successful trade.

The spread can be looked at as a hidden cost because the magnitude of them is not apparent during a trading session to the trader.   One of the easiest ways a trader can avoid these hidden costs is find a solid reliable broker that offers reasonable pricing on spreads.  The easiest way of achieving this is by price shopping.  When working with a broker find out if the spreads are fixed or variable.   Again, by doing this you will give yourself a leg up on a potential winning trade.