2.12. Trading Costs.

trading cost formula

If you are a day trader which closes every trade every day, then you can omit negative swap cost. Be careful to take notice what time your broker will charge swap. And on Wednesday your broker will charge swap rate three times as big as other days.

In this section I want you to be aware that trading cost is very important when you design your system.

Spread. Your broker will charge you spread every time you take a position either buy or sell.

For example: If you are a scalper who takes 10 pips Target Profit and 10 pips Stop Loss and your broker charges you 2 pips for spread. Your trading cost will be 20% (20% = 2 : 10 x 100%).

Another example: If you have 25 pips Stop Loss, 50 pips Target Profit and 5 pips spread. Your transaction cost will be 10% (10% = 5 : 50 x 100%) if you win, but if you lose your transaction cost will be 20% (20% = 5 : 25 x 100%).

Swap. Swap is the interest you will get or you have to pay for overnight position. Whether you will be deducted or you will gain from swap depends on your position. You can get swap rate information from your MT4 trading platform. If you look at the table below, swap long is 4.6 points and swap short is -6.9 points. It means that if you open BUY one standard lot than you will gain 0.46 pips everyday and if you open SELL you will be deducted 0.69 pips everyday.

Aud-Jpy swap rate 2013-11-15

A lot of traders underestimate the power of swap. If you trade against swap, it will eat your profit slowly and it will bite a big chunk of your profit at the end, especially if you use high leverage. It will reward you nicely if you trade with the same direction of the swap.

 

Let’s use NZD/JPY example from the leverage section.

You deposit $20,445 and buy 1 standard lot NZD/JPY on Oct 2008 at 52.415. You set your Target Profit at 68.000 and it is achieved in Oct 2009. Swap long rate is 10.2 point (=1.02 pips) (Swap rate is used to be higher before the economic crisis) and swap short rate is 11 (=1.1 pips). Spread is 7 pips.

Since you deposit only $20,445 to buy 1 standard lot NZD/JPY, your true leverage will be 1:2.56 (2.56 = $52,415 : $20,445). You will gain $15,585. If you use leverage of 1:2.56, your return will be 76% ($15,585 : $20,445)

Nzd-Jpy 2008 c

Spread Cost without leverage will be $70 ($70 = 7 pips spread x pip value $10 for standard lot). It is 0.45% of your gain (0.45% = $70 : $15,585  x 100%)

Spread Cost with 1:2.56 leverage will be 1.15% of your capital (1.15% = 0.45% x 2.56). Notice that your spread cost is still the same $70, but the proportion of the gain will be magnified with your leverage.

You are in the trade between Oct 2008 and Oct 2009; just assume it is 365 days. Swap gain without leverage will be $3,723 ($3,723 = swap long 1.02 pips per day x 365 days open trade x 1 lot x $10 pip value). Your swap gain is 7.1% of your capital (7.1% = $3,723 : $52,415 x 100%).

Swap gain with 1:2.56 leverage will be 18.17% of your leveraged capital (181.7% = 7.1% x 2.56). Notice how much gain you will get from swap, especially if you use leverage. In this example you only use 2.56 leverage. Just imagine how big your cost would be if you trading against the swap. The cost would be more devastating if you use high leverage.

So instead of just get a 76% return, altogether you will get 94.18% ROI in a year. Very nice indeed. Pay attention that you only use 2.56 true leverage.

 

Some traders (scalpers) put their Target Profit and Stop Loss < ATR. By doing this you will make your broker a very happy and rich man. If you scalp 10:10 (10 pips Stop Loss and 10 pips Target Profit) and the spread are 2 pips. Your transaction cost will be 20% regardless you win or not. Some scalpers even go for 5:5; can you imagine that your transaction cost will be 40%. I don’t think you can make money by scalping. Some traders will argue, but for sure, it is not a system for beginner.

 

In summary:

  • It is very important to know what your transaction cost per trade is.
  • Always make your transaction costs as low as possible. You do this by making your target profit high enough to offset your transaction cost.
  • Transaction costs will always be deducted regardless you win the trade or not.
  • Leverage will magnify your transaction costs.
  • Scalpers have very high trading costs. 20%-40% transaction costs are common. Do not scalp because in the end you always lose because of the very high transaction costs.
  • Do not underestimate the power of swap.
  • If you are a long term trader then do not trade against swap.
  • Make swap your friend not your enemy. You will get a nice return from swap alone.
  • By making swap your friend then you are making friend with time also. The longer you are in a trade the more swap income you will get.