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The Cost of Forex Trading

I was asked by frequent emailer Rod to address something he came across regarding the cost of forex trading as compared to trading other markets, like futures. He is referring to this blog post in which the author compares retail forex to emini S&P 500 futures. In particular, the following statements are made:

“…unlike a stock, option or futures trade where one pays to enter and again to exit (but not to hold) a FX position is inherently a short-term trade, as you will be charged simply for the privilege of holding your position open over a period of time.”

“If you short the Euro/USD cross, for example, and expect a 100 pip (one cent) move on your trade, you might pay three pips of spread to enter and another three to exit, for a total “vig” of six pips.  That’s a 6% commission!

There’s plenty for me to address here.

Spreads and Commissions
I’m going to start with the second quote first because there is one blatant error, and other less obvious ones.

First of all, you don’t pay two spreads. In fact, you don’t really “pay” a spread at all, though certainly it is a cost. The only time the spread impacts you is when you first open a trade. Let’s say the market is at 1.4500-1.4503. If you go long, you will enter at 1.4503 ask/offer price. Now in order to exit your long you would sell at the bid price of 1.4500. As a result, you have a 3 pip loss from the outset. That’s the only time the spread comes out. If the market moves to 1.4600-1.4603 – the 100 pip gain noted in the quote – you would exit at 1.4600 for a net gain of 97 pips, not 94 as suggested.

Second of all, the 6% calculation is based on being leveraged at 100:1. I’ve already shown that the spread loss is not 6 pips, but rather only 3, so that cuts the cost to 3% on a fully leveraged position. Most traders, however, don’t go anywhere near 100:1 leverage. Experienced folks often limit themselves to 10:1-20:1. At 20:1 the spread cost is 0.6%, while at 10:1 it’s only 0.3%.

But wait! The 6% calculation is also based on erroneous figures. It assumes that a full contract is worth $100,000 and a pip is $10. The value of a full EUR/USD lot priced at 1.4500 is $145,000, for which $1450 would have to be posted as margin at 100:1 leverage. A 3 pip spread value of $30 on that full contract would thus only be about 2%.Going with the lower 20:1 and 10:1 leverages noted above, the more realistic cost for the trader is 0.4% and 0.2% respectively.

Thirdly, the blogger fails to account for the fact that futures have spreads too. I see this happening all the time – people claiming that other markets don’t have spreads, or simply being ignorant of the fact. The usual spread in the e-mini S&Ps is a quarter point, or $12.50. The round-turn commission the blogger mentioned in his post was $6, so when you factor in the spread cost you get $18.50. That’s about 0.4% when the blogger’s $4050 initial margin requirement is applied. Looks pretty comparable to me.

Carrying/Holding Costs
Now back to the subject of the first quote. The blogger is correct that there isn’t a carrying cost for trading stocks (unless you’re doing so on margin, in which case you have interest expenses). There is carry for all the other markets, though.

In options time decay is a cost of carry for those long the option, but a benefit for those who are short. In futures there is a spread between the contract price and the spot market price, which moves to zero as the contract nears delivery. In some cases the spread is positive, while in others it’s negative. Obviously, the forex market has daily roll-over/carry which can either go for or against the trader depending on which way the interest rate spread is going.

In other words, unless you’re a short-term trader, there is a carry involved in all the markets except stocks. To claim otherwise is to be misinformed.

Cost Competition
Keep in mind too that it behooves forex brokers to be price competitive when compared to futures. If not they stand to lose especially their bigger customers (and thus their bigger volume) to the futures market.

The bottom line is that retail forex trading is pretty comparable in terms of its costs to other markets available to individual traders. If you have any doubt about that, do the math for yourself based on your own trading.