Every forex broker charges a fee on each trade, which is how they stay in business. Most traders only take into account the most common fees, which are spreads. However, there are many additional and somewhat hidden costs that are incurred while trading forex, and they could greatly impact the outcome of your portfolio.
Ideally, a transparent broker should have a breakdown of all their fees on their website, but let’s face it, we live in an imperfect world. So, buckle up as we break down the direct and indirect costs associated with forex trades.
Direct trading costs
Direct costs are charges such as spreads, commissions, storage fees, custodial fees, swap rates and overnight financing costs. However, not every trade you execute will incur all these costs. The costs that apply to trade are dependent on the type of asset you’re trading, whether you’re trading it on a margin and how long you intend to keep your trade open.
Ethically, every broker should display all the costs applicable to trade in their trading conditions or on their trading platforms. Most brokers will provide a calculator on their platform, on which you can calculate the cost of each trade before you place it. Let’s take a look at what exactly each of these costs is.
In the Forex market, brokers usually quote two prices, a bid and ask price. A bid is a price at which a broker buys a currency, while the ask is the price at which the broker is willing to sell that currency. The difference between the bid and ask price is the spread.
For example, at the time of writing this, EUR/USD was trading at $1.1800. A broker’s quote for this currency pair may be $1.1800/1.1850. If you wish to buy euros from the broker, you’ll be charged the ask price of $ 1.1850. Alternatively, if you wish to sell your euros to the same broker, assuming no price change has occurred, you’ll get a bid price of $1.1800. The broker’s spread is the $0.0050 difference or 50 pips.
This is an outrageously wide spread and atypical to the market. Usually, the spread varies from one to five pips. However, the spread can fluctuate suddenly depending on the prevailing market conditions. Further, different brokers may quote different spreads for the same transaction, which is why market research is vital before you commit to a trade.
Some brokers’ accounts could quote spreads of 0.0 pips on the EUR/USD, and instead, the broker charges a commission per lot. This is more common in ECN accounts that offer no-dealing desk (NDD) executions.
Commissions are deducted the moment you open a position. That way, the broker makes money regardless of whether you make a profit or a loss. Commissions also vary with volume. The bigger the volume traded, the more commission you incur. For instance, say you trade 0.1 lots, and you’re charged a $0.5 commission. It follows that if you trade one lot, the commission will be $5.
However, some brokers may charge lower commissions per trade the more volume a certain client trades, as an incentive to keep the client’s business.
Also known as rollover, a swap rate is an overnight interest added or deducted when you hold a position overnight. Rollovers depend on the interest rate differences between a base currency and the quote currency of the pair being traded and whether the position is long or short.
Swap rates may be positive or negative. Negative swap rates will be deducted from your account balance, and you should check to ensure your broker debits all positive swap rates to your account.
Overnight financing costs
These are fees charged on leveraged trades, which cover the cost of holding your position open overnight. On leveraged trades, you only pay a percentage of the minimum amount required to keep a position open, which means you are effectively being lent the rest of the money. At each end of the day, an interest adjustment needs to be made to cover the cost of financing your position overnight for as long as your position remains open.
Some brokers will charge you a fee for holding certain assets in your account. This fee is usually in addition to swap fees and financing fees. It is an unethical fee, and such brokers should be avoided.
When you buy assets such as ETFs, equities, and bonds, your financial custodian will charge an annual or monthly fee for keeping custody of your assets. However, when you use CFDs since you do not own the underlying asset, you do not incur custodial fees.
Indirect trading costs
Indirect fees are costs that are not charged per trade. They include withdrawal charges and account inactivity fees. Usually, brokers do not charge their clients a fee to deposit money into their accounts. Withdrawal fees are also more likely to be charged by the client’s bank than the brokers. For account inactivity fees, some brokers will charge these with every quarter of inactivity until the client’s balance zeros or trading is resumed.
As a general rule of thumb, brokers will highlight all the fees and charges that are applicable to their clients on their websites. It is paramount that you review your potential broker’s trading conditions to determine which fees will be applicable to you before you place a trade with them.
Further, most brokers will provide a calculator on their website, with which you can calculate the cost of trading an asset or a certain volume of an asset with them. Spreads and swaps are always fluctuating, so you should be careful to check the prevailing rates on your broker’s trading platform. You should also make sure to track swap rates, as some brokers have been known to withhold positive rollovers from their clients.