Running a business comes at a cost. The same goes for your trading business. Broker costs will count for a large part of these costs. The cost of trading is the overall expense that a trader pays to run his or her business.
According to the above, we can see a broker as a business partner or a trading partner. The broker provides the technology and the trading platform so we are able to initiate trades in the forex and CFD trading market. The broker also provides liquidity, leverage and other tools to identify the market. In return the broker charges spread or a commission on the trades we place. This also means that the broker and trader have a common interest, since a broker will only earn money whenever a trader initiates trades.
The spread or commission that brokers charge is usually very low, but will have a bigger impact when you increase your trade size or trading frequency. If you don’t pay attention to all of the costs involved, they will limit your ability to make a profit. As you may well know there are a lot of brokers that offer tight spreads and low fees. But what does this actually mean?
A better insight in broker costs will make you more aware of your trading in general and the possibilities to keep broker costs under control. In this article we will discuss how a broker makes money, which broker costs apply to trading and how we can keep these costs as low as possible.
How do forex and CFD brokers make money?
Forex and CFD brokers make their money on us, the traders. Although this seems like a common enough answer, there is more to the story.
When we visit a broker’s website we usually come across a list with all the spreads, commissions and fees a broker will charge when using its services. A broker will usually say it offers tight spreads and low commissions. A good broker will mainly make its money on transaction costs for opening and closing positions. Furthermore a broker will charge fees for overnight funding and currency conversion. It is only fair a broker charges costs since it provides market access and liquidity. But is it actually true that a broker only makes money mainly on transaction costs and does a broker really want its customers to succeed?
Luckily this is mostly the case. There are brokers in the market however that make money of client’s losing trades or even bet against their own clients. This means that there are brokers who made it their business model to actively profit from your loss. Luckily, forex and CFD trading is highly regulated in most countries and good brokers are reasonably easy to recognize. We will however give you some more explanation and some useful tips on what to look out for later in this article. First we will take a look at the types of costs brokers charge.
Types of Forex and CFD broker costs
Depending on the type of product, there may be the following types of costs:
Fixed or recurring charges for maintaining a trading account
Most brokers will not charge clients for having an active trading account. This is only fair since a broker makes money of its clients when they are trading. What you do have to watch out for are so-called inactivity fees. When you did not use your account for a certain period, some brokers will start charging a monthly inactivity fee. Some brokers will already start charging after a period of three months where other brokers will only start charging a fee after a year. Beware of trading accounts that you might still have but don’t use. You might be bleeding money here.
Spreads and commissions
Spreads and commissions are the transaction costs for opening and closing positions.
What is a spread in forex and CFD trading?
When a price for a market is quoted, you will see two prices. The first price is the bid price. This is the price buyers are willing to pay for a market. The second price is the ask price and represents the minimum price that a seller is willing to take for the same market. The difference between the bid and ask price is called the spread.
Most brokers will quote their prices in the form of a spread. This means that when you buy a market, you will pay a price that is slightly higher than the market price. When you sell a market, you will sell at a price that lies slightly below the market price.
Spreads can be fixed or variable. Spreads are usually tighter in liquid markets.
What is a commission in forex and CFD trading?
A commission is the fee a broker charges when you open a position. It does not matter in which way you open the position (long or short). A commission can be a fixed fee per trade or a relative fee that is based on a certain market volume.
When you open a trade the spread or commission will be deducted from your available equity right away. This means all trades start with a small loss and the market will have to move in the right direction a bit before the numbers on your screen turn green. Most brokers will charge a spread or a commission based on the product that is traded. Some brokers will charge a small fixed fee per transaction and on top of that the relevant spread.
Financing fees or overnight costs
What are financing fees?
Financing fees or rollover fees are charges that you pay to hold a forex or CFD position overnight. Some brokers use the term overnight funding. Financing fees are automatically applied to a trading account each day an open position is held. This also counts for the weekends.
In forex trading it is possible to actually make small amounts of money on rollovers. This has to do with the financing rate. The financing rate or rollover rate is the interest that you pay or earn for holding a position overnight. Brokers use interbank rates for this, which are the rates banks apply when lending money between themselves.
When trading a forex currency pair you buy (long) one currency and sell (short) the other. Each currency pair will have an interbank interest rate. You will earn interest on the currency which you buy and pay interest on the currency which you sell. The difference between the two interest rates is the net financing rate. If the currency in which you are long has a greater interest rate than the currency in which you are short the net financing rate will be positive and yield a credit. The other way around would yield a debit.
For CFD positions in markets like indices and stocks you will most likely not receive any money for short positions.
Currency conversion charges
It is well possible that you regularly trade in markets that settle in a different currency than your account’s base currency. In this case your broker will apply a currency conversion charge.
For example, if the base currency of your account is EUR and you trade EUR/GPB (Euro/British Pound), any realized profit or loss, as well as any relevant commissions and fees, will be automatically converted from GBP back to EUR before shown in your account. Most brokers charge +/- 0.3% or 0.5% from the market rate at the time of conversion. If you only trade products that settle in the base currency of your account you will not be charged for any conversion.
Costs for live prices and data feeds
Not all brokers offer live quotes for their products. This is because of how brokers price their products. Many brokers act as so-called market-makers, which means that a broker partly sets his own prices for the tradeable markets. Usually we base ourselves at the broker’s price and not on the market itself. The underlying market will serve as a reference for pricing. The difference between the market price and a broker’s price is normally very minimal.
Brokers will offer live prices and data feeds for a fee. These can usually be found on the broker’s website.
Costs guaranteed stop loss
What is a guaranteed stop-loss order?
A guaranteed stop order is a type of stop-loss that makes sure your position is always closed at your pre-selected price. A guaranteed stop-loss order is a risk management tool that can be used in volatile market conditions and removes any risk of slippage. This means that when a market price moves suddenly and skips your stop-loss level, the position will still be closed at the level you selected when you entered the trade.
A guaranteed stop-loss does not come for free since the broker will have to cover any losses beyond the guaranteed stop level. Most brokers only charge for the use of a guaranteed stop-loss when a stop level is actually triggered. Brokers usually charge for the use of a guaranteed stop-loss in the form of a wider spread or as a fixed percentage of the trading volume.
We have already discussed the most common broker costs. Depending on the broker and the services a broker offers, there might be other costs involved. These costs are usually optional and are only charged for additional services. A broker might charge for additional chart packages, news services, custom technical analysis, faster connections, implementation of changes in positions and so on.
How to keep forex & CFD broker costs low?
Now we know what kind of costs brokers might charge it is time to look at ways to keep these costs as low as possible. Lower broker costs will have a positive effect on our trading results and will make us more aware of our trading activities.
What kind of trader are you?
Finding out what kind of trader you are will partly define your needs as a trader. When you are a daytrader or a scalper you heavily rely on charts to make your trading decisions. This kind of trader cannot do without accurate charts that show live prices. Traders who stay in position for a longer time, like swing traders and especially position traders, also look at fundamental factors and therefore need good market analysis tools. Event-driven traders rely on news and try to benefit from political and economic events.
Algorithmic traders rely on computer programs to trade for them. Algorithmic traders use a defined set of instructions to enter or exit trades when certain conditions are met. Besides access to technical charts, algorithmic traders usually need a fast internet connection and a VPS-connection. Investors who do not have any programming knowledge, but do want to explore the possibilities of algorithmic trading, can take a look at the Major Markets Trading forex automatic trading system. Major Markets Trading offers an easy to use trading system that comes with a free VPS-connection.
You have to ask yourself what you really need to fulfill your trading needs. We are a fan of simplicity. If you don’t need it, don’t spend money on it.
Understanding the total cost of trading
Make sure you understand what you are paying for. Moreover, make sure you know WHY you are paying. A good place to look is the trading history in your trading platform. Here you will find an overview of all of the costs that a broker charges. In some trading platforms you can even select the different kinds of costs that are being charged so you can see what has the most impact. If you are not sure why your broker charges certain costs, do ask. All good brokers will be more than happy to give you an explanation.
Different brokers charge costs for the same services. The height of these costs however, and how they are charged, may differ considerably from broker to broker. We have already discussed spreads and commissions. These will have the most impact on your trading costs. The minimum or average spread that a broker charges might not be the actual spread that you are paying. The actual spread depends on market conditions and volatility. It can also be that a broker uses a fixed spread, but charges a commission that is based on your trading volume or amount of trades. Your frequency of trading will be a determining factor in the height of your trading costs.
For the other types of costs it is also useful to compare costs. Try to calculate the total costs of trading based on your trading activity. For this you can look at trading volumes, trading frequency, traded markets and when you are trading.
To get a good feel for trading costs, a comparison between different brokers is always a good thing. It is of course possible to have multiple trading accounts at different brokers. There is also the possibility to use a risk-free trading environment, by using a demo account. This way you can test new trading systems or trading strategies without any costs. Traders who choose Admiral Markets can trade completely risk-free with a free demo trading account. Instead of going straight to the live markets and endangering your capital, you can avoid the risk altogether and just practice until you are ready to switch to live trading.
Watch the spread!
Make sure you understand and accept the spread for the products you trade. The spread for a certain market can vary from time to time. This has to do with liquidity, volatility and trading hours.
In the case of leverage products, differences can arise between the prices that the broker offers and the prices of the underlying market. This occurs especially in case of rapid and large price changes. It can happen that a broker can only offer delayed prices or in the worst case no price at all. Uncertainty and increased volatility can cause brokers to widen spreads. Most traders will look for low and stable spreads.
Many brokers offer the possibility to trade markets outside of their normal trading hours. This is also referred to as “out of hours” trading. Since the broker cannot refer to the underlying market to set prices, there is a certain level of uncertainty. This uncertainty will result in increased spreads. It is not uncommon that brokers charge 3 times, or even 5 times the usual spread outside of the normal trading hours. It is important that you are aware of this and take this in consideration when entering a position.
Just remember that financing costs can add up. Traders who enter and exit a position within the same trading session, will not have to worry about financing costs. When you hold positions overnight this will become relevant for you as a trader. When you have a clear idea about when to enter and exit a position you will be able to calculate the financing costs exactly.
The problem starts when you keep loss positions running for a longer period of time. For a trader it can be difficult to close losing trades. Especially when you have the idea that the market will turn around and you might be able to close the position with a profit. As long as a position will be open, you might be paying financing costs. The same goes for running profits. Many traders know the saying “let your profits run”. You will however have to monitor your open positions and make an estimate on how financing costs impact the expected outcome of the position.
Leverage inflates costs!
As traders of forex and CFDs we use leverage to increase our exposure to the markets. Leveraged products will increase our potential profit, but also our potential loss. It is very important to understand that a high leverage, and therefore a high trading volume, will inflate costs. A broker will charge you based on your market exposure and not on your initial deposit.
For example, let’s say you would like to trade a stock CFD of company ABC, with a 1:10 leverage. When your market exposure or trading volume is € 5000, the initial margin deposit will be € 500. The commission for opening and closing the position, as well as any financing costs, will be charged based on your market exposure which is € 5000.
When you trade less you pay less. This might sound a bit too easy but it does actually have more meaning that you might think. Many traders are impatient and would like to enter the markets as soon as they open. Even the more experienced traders we often see trading, while in fact the market doesn’t give any interesting signals at all. The results of trading too often are often marginal and you will just lose money on spreads and commissions.
Trade what you know
Some traders will trade every market that is available to them. Not only will your trading results improve when you only trade a few markets, your costs of trading will go down as well.
Develop a trading plan
Always make sure you are trading according to a trading plan. A good trading plan provides guidance and enables you to make better decisions. In addition, you can use a trading plan to further improve future results. Topics that are addressed in a good trading plan are: financial goals, trade and risk management, money management, checklists for opening and closing positions, markets or products to be traded, trade sizes, desired risk-reward ratios, evaluation of available knowledge, time available to trade, evaluation of personality, determination of stop-loss and take profit levels, determination of available amount for trading and the registration of all trading activities.
A trading plan will prevent that your trading costs get out of control.
Choosing a forex or CFD broker
Make sure to use a regulated and well known broker only. Regulation already says a lot about the reliability of a broker. Trading involves risks. There is absolutely no need to open an account with a broker that is not well established or cannot be verified online. It is as simple as that. Good brokers offer their services according to regulations and have to compete with other established brokers. Therefore you will less likely come across a broker that charges fees that are not in line with the market. More information about how to choose a good broker can be found in this article.
Hopefully the information in this article will help you lower your broker costs. In the end, the reason why traders lose money is not because of the broker, it’s because of the trader. Major Markets Trading offers practical information about trading and investing that is easy to read and to use. If you have any questions or you would like to talk to us, feel free to contact us any time.