Since trading forex is very much akin to a business, recurring expenses are inevitable. The job of any trader is to minimize such costs to increase the profit potential. Some may not be aware of the true levies for speculating in the forex markets.
While many of these aren’t necessarily hidden fees, they can surprise a few, especially on larger accounts. Some of the costs are more prominent than others, requiring more attention; others are less significant but noticeable nonetheless.
This article will look at the six costs every forex trader should know and ways to reduce them where feasible.
It may not necessarily be a so-called expense compared to spreads or commissions, though losses are the easily highest price of trading forex for any trader. Essentially, they are the real cost of doing business in forex and, if not appropriately managed, can spiral out of control.
The key is to keep losses at a consistent amount on a per-trade basis. Here are a few other important considerations in this regard.
- Traders should ensure there is enough money in their accounts to maintain all the margins of their positions. Having an under-funded account can quickly lead to margin calls due to over-leveraging.
More importantly, it’s best to focus on the real monetary value of the risk instead of a percentage of the equity.
- Based on thorough testing, a trader must risk an amount that will allow them to go through an extended drawdown in the worst-case scenario. Allocating more money down on each position lowers the room for error and can quickly wipe them out.
- While it sounds cliched, stop losses are crucial for managing the downside, assuming the trader knows how to use them appropriately.
Spreads and commissions are understandably the most recurring charge in trading currencies. Regardless of whether an order is closed within a second, the position is already negative in most cases. Although spreads are the main cost, the competitiveness of brokers over the last decade has dramatically reduced these fees overall.
Very rarely nowadays will one find any broker offering above a two pip spread, for instance, on EUR/USD. Generally, spreads are consistent across the board, and anomalies might only exist for unregulated brokerages.
Moreover, the old practice of brokers marking up the interbank spread and adding their commission on top is relatively obsolete, at least for adequately licensed entities. However, it’s still essential to understand when a broker should charge a spread and when they should charge a commission.
This depends entirely on their execution model and the type of offered account. Brokers using the so-called STP (Straight Through Processing) method of passing their clients’ positions directly to the interbank are only supposed to have a spread.
In contrast, firms using the market maker or dealing desk model can offer fixed spread accounts. Here, the spreads tend to be lower than usual, though the broker is legally obliged to add a small commission for each trade. Here are the main considerations for lowering these costs:
- Variable spread accounts are better suited for long-term speculators who don’t execute frequently. Execution costs are exacerbated partly because of high frequency, a trait that’s common with scalpers and day traders.
Thus, this latter group should consider fixed, or zero spread accounts for the lower spreads. Also, these accounts have more predictable costs on a per-trade basis, unlike the variable version, where spreads can increase dramatically during busy and illiquid trading periods.
The latter events can lead to the rare possibility of slippage, which unfortunately isn’t avoidable in forex.
- Exotic pairs are the markets with the highest spreads, and this is where we can see some notable differences between brokers. Newer traders and those trading quite regularly should generally refrain from most exotics.
Swing and position traders are better suited to these instruments as their profit targets are larger and can easily compensate above the spread. This group should also consider using a fixed spread account for exotic markets.
Swaps/overnight funding fees
Rollover fees for major and minor pairs are relatively minimal with most brokers as the countries represented in these currencies have lowered their interest rates dramatically. Yet, depending on if the position is a long or short one, exotic pairs can have noticeably higher swaps.
Of course, negative swaps only affect any trader holding their position overnight, though they can accumulate to a sizable amount over time. There is a formula brokers use to calculate these charges, though the calculations are not exactly the same considering they also add their mark-up.
For long-term speculators in exotic pairs, it’s crucial to compare to find the best deal. Another option is Islamic or swap-free accounts. While these are typically reserved for Muslim clients, some brokers have been known to offer them for non-Muslim traders; but this is the exception rather than the rule.
Fortunately, most brokers offer commission-free funding for most depositing methods. It’s recommended traders fund with a supported debit or credit card or at least an e-wallet services like Skrill or Neteller because they rarely incur any fees and clear instantly.
Traders should avoid bank wire transfers in the funding stages. However, the policy with most brokers when traders become profitable is returning all their deposits via card or other options and sending back the remainder via bank wire.
At this point, the receiving bank will levy a fee. Most brokers nowadays generally don’t have a processing fee for this payment method. Overall, traders should prioritize firms with no depositing or withdrawal fees for most of their available payment options.
Currency conversion charges
This charge is easily avoidable and not one most traders should encounter. Though if a broker only has a limited number of base currencies for their accounts, conversion fees can apply.
The majority of firms offer USD, EUR, and GBP accounts, but others can provide at least five more for various purposes as some traders prefer to trade in their native currencies. The easiest solution is funding according to the denominated currency of the offered account.
For traders insisting on using a different currency, it is vital to know the conversion fees and calculate if they might be too high should they perform more transactions.
Like most financial instruments, taxes are liable in forex for most countries. Of course, the taxation laws vary widely, but it’s a fair assumption many developed nations require their citizens to pay tax above a certain threshold.
Typically, the respective authorities would classify forex profits as some form of income or capital gains payable after a fiscal year. There are some legal methods to minimize these expenses, though it’s important for clients to stay on the safe side and understand the tax principles in their specific countries.
As evidenced in this article, several costs do affect a trader’s profitability and overall trading experience.
Like any savvy businessperson, once such expenses have been identified, it becomes necessary to reduce them where possible to ensure the bottom line remains as intact as possible.