FOREX Trading Costs

The cost of a FOREX transaction consists of spreads, lot fees, and rollovers. Spreads between the bid and ask affect every trader. Lot fees are indigenous to ECNs and rollovers tend to be less than meaningful unless you hold a position over a long period of time.

Spreads are the difference in pips between the bid and ask price of a currency pair. On your trading platform, you will see something like this:

EUR/USD 1.3574/1.3576

The first number is the price you can sell the pair, the bid. The second number is the price you can buy the pair, the ask.
This spread varies from pair to pair, session to session, and from broker to broker.

The major pairs have the smallest spread because they have the most activity and volume, called liquidity. The exotic pairs have the widest spreads because they are thin and illiquid. Consider the EURO-South African Rand:

EUR/ZAR 7.9823/7.9978

One must also remember that 7:1 is a much larger differential than 1:1.35, so the pip values are naturally smaller. Nonetheless, this is a very high spread.

Spreads tend also to be lower when the currencies -- or at least one of the currencies -- in the pair are in session, whether that be the North American, European, or Asian session. The bid-ask for the AUDJPY (Australian Dollar-Japanese Yen) will tighten during the Asian session and move out during the North American session, all other factors being equal. News may increase activity and tighten spreads.

Spreads will also widen before, during, and after news releases as the market thins while traders make critical decisions. Market makers may widen spreads before a news release to discourage news trading. Simply slowing down the stream of prices from the data feed will have a similar effect.

The more bid-asks that come in to a broker, the tighter the spread will be for the trader. More and bigger liquidity providers create liquidity within the broker's data feed.

Spreads on majors generally run from zero to five or six pips. Minors, five to ten pips, and exotics even higher. The more actively you trade, the more critical will be spreads to your bottom line. For position traders, a few extra pips will not mean anything. For a guerilla trader, they can be the difference between success and failure.

Tip: Before pulling the trigger on a trade, check the bid-ask spread to make sure you know what you are paying. The more short-term your trading, the more signficant will be the spreads over a period of time.

Lot fees are how ECNs make their profit. ECNs have tighter spreads but since they don't profit by marking up the spread as market makers do, they have to charge a lot fee for each transaction. Most traders will do better with an ECN although very-short-term traders may actually benefit from a reliable market maker.

Lot fees vary from broker to broker, but in general they have dropped in the past two years. $3.00 to $10.00 per 100,000 is the primary range. Some ECNs actually offer rebates for active traders to encourage liquidity. Remember your bid or ask becomes part of the data feed and adds to the liquidity pool.

Rollover charges are determined by the difference between U.S. interest rates and the interest rates of the corresponding pair country. The greater the interest rate differential between the two countries in the currency pair or cross, the greater the rollover charge will be. For example, if the British Pound (GBP) has the greater differential with the U.S. Dollar (USD), then the rollover charge for holding the GBP positions would be the most expensive. Conversely, if the Swiss Franc (CHF) were to have the smallest interest rate differential to the U.S. Dollar, then the session carryover (overnight) charges for the USD/CHF would be the least expensive of the currency pairs.

Rollovers are a complex issue, and fortunately of limited importance to the small trader. If you trade intersession a substantial amount of the time, ask for specific broker-dealer policies on rollovers; they do vary, and some are much better than others.

Some dealers offer interest on your unused account balance. Again, policies within those companies differ. If you have a large amount of unused account monies, it can make a real difference. Larger traders tend to get better deals to keep them from shuffling money in and out of their accounts to maximize interest.

Trading FOREX is a good deal, cost-wise. But they are still there, and the more you trade, the more they will affect your bottom line. It definitely pays to shop, especially if you intend to be a short-term trader, generating many traders over a session.
By Michael Duane Archer
Michael Duane Archer has been an active futures and FOREX trader for more than 35 years. He has worked in various advisory capacities, notably as a commodity trading advisor, registered SEC investment advisor, and branch manager for Heinold of Hawaii. He currently trades FOREX and futures and is involved in several technical analysis research projects.

Copyrighted 2016. Content published with author's permission.

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