From slippage to income tax, here are several hidden costs in forex trading that you should know if you want to give full commitment as a full-time trader.
People join forex trading to get some additional money through profit. They choose a brokerage that might help them to gain profit. However, brokerages or brokers come with some costs that sometimes impact on the profitability. Therefore, to consider the costs of the brokerages whether they are reasonable or not, you should check the trading commissions, withdrawal fees, spreads, as well as account maintenance.
The information on those costs is easy to get because they are always announced on the brokers' official websites. You only need to make sure that the costs are reasonable for your standard. However, have you known about the hidden costs from forex brokers?
Slippage is a part of the ECN/STP environment trading that is usually considered as negative. Here is the example of slippage in a demo and a live account:
You open a BUY position for EUR/USD on the demo account that does not offer actual transaction and no subject to slippage. Your transaction is executed with the market price of 1.10543 and is closed at 1.10600 with 1 lot trading volume. The difference between those prices is 57 points, so it will translate into your profit on the demo account.
Now, let's turn to the real account. A real trading account is subject to slippage. Let's say the negative slippage at the open price is 10 points, causing the position to be executed at 1.10553. When the trade is then closed at 1.10600, your profit will only amount to 47 points, 10 points fewer than the position in the demo account.
As a matter of fact, there is also a positive slippage that possibly brings some significant effect on the profits, especially for the limit orders. A limit order is normally set at a fixed price or a better price. The fixed price means without slippage while the better price means positive slippage.
When the limit order is set, it is usually led to a marked-up price at the Liquidity Provider. This enables brokers to eliminate negative slippage while ensuring the possibility of positive slippage. The absence or presence of positive slippage should be considered by traders since it becomes one of the main considerations of a broker's business ethics and credibility. A fair trading condition is the one that gives the probability of positive slippage. If your broker's slippages only result in profit reductions or bigger losses, it can be considered as a damaging hidden cost that you need to watch carefully.
The Top-of-the-book Spreads
Spreads among brokerages are not the same. The more attractive brokers, the lower spreads they have. Besides, they are prone to drastic changes in illiquid times (when the spread widening happens) and during the release of important economic news. A spread is a must-pay fee that is fulfilled automatically in every trade.
Usually, brokers display the real-time spread comparison with or without the commissions on their websites. They know that the official website is an important first impression for the upcoming clients. The clients then assume the spreads displayed are the real ones that they will get once they open an account in the broker. For your information, not all of the details are accurate because it does not show the real trade execution.
The displayed spreads on the broker's website are usually the top-of-the-book spreads. They may only show the best price for about 5 lots of transactions, whereas the spreads for the next lots can be several pips different. Based on the broker's size and the number of active clients, the opportunity of becoming the client included at the top-of-the-book spread is rare. By considering the average price, you will get a better indicator in knowing how the trade will be filled.
The Commission and Profit-Loss (P&L) Conversion
The commission is also always charged by the broker every time a client opens a position. It is deducted from the account balance. If the volume increases, the commission also increases, and vice versa. Some brokerages choose to offer very tight spreads and charge their clients with commissions. Other brokerages choose to announce on their website that they charge for relatively big spreads with no commissions. If you trade in the first type of broker, pay attention to this.
You should beware of the exchange rate of the commission and P&L conversion to your currency. The conversion should happen with a valid rate as displayed on the trading terminal when the broker charges the commissions. It is also important to know that the calculation needs to be done immediately at the rollover. It is because the currency rate might be different between the rollover and at the time the commission and P&L incurred.
The Funding Cost
Funding cost means some cost you must pay when you put a deposit on your account. The cost is usually charged by the facility enabling the money transfer to your account. Therefore, funding costs can be different based on payment methods. The most common methods offered in forex brokers are bank transfers, credit card payment, and electronic payment via e-wallets.
The Swap Rates
Normally, a currency with a high interest rate is stronger than other currencies with lower interest rates. It means the currency value relies on the interest rate. In a forex pair, the two currencies generally come with different interest rates. The rates are also prone to change as central banks sometimes need to lower or increase their interest rates in response to the current economic condition.
The difference between interest rates of two currencies in a pair is a swap. It can be positive or negative, depends on the currencies involved and the type of position that you open. In forex trading, the swap rate is only applied for overnight positions. If you don't have a floating position that you keep holding to the next trading day (based on your broker's server time), then you will not be charged with the swap rate.
Interestingly, traders are often misled by the opinion that positive swaps are worth the effort of analyzing and turning into a trading income. It may be true for some experienced traders who apply the carry trading strategy, but it can be a complicated matter for beginners who don't really understand the intricacies of forex fundamental outlook and the big picture analysis.
For most traders, the understanding of the swap rate can be limited to an unexpected trading cost incurred by the broker. Hence, you should monitor the swap rates of your broker especially if you tend to have overnight positions.
The false opinion among traders is that the biggest drawback of forex trading is due to errors in their trading strategy. While the notion is not all mistaken, it leaves the hidden factor not all traders are aware of; the tax that can reduce the profit earned from trading. In some countries, the taxes should be paid when the profit is accumulated and informed at the year's end. This is particularly relevant for traders living in a country that recognize forex trading profit as a taxable income.
If you live in such a country and plan to be a long-term trader, this hidden cost should be included in your considerations when weighing the pros and cons of being a full-time trader. Tax information is not provided by your broker as it is a policy implemented by the government. So, it is imperative for you to learn the amount and the payment mechanism of the tax charged to your trading income.
Hidden Costs in Forex Trading Could Interfere Your Income
It is normal to try making a profit for each trade. You can optimize your trading strategy, manage your capital, and train your trading psychology as best as possible. Yet, you also should be aware of the hidden costs above as they may reduce your profit or even add to your loss if not regarded carefully. Be a smart trader who is always considerate of all commissions and costs because, in the end, the net amount is the most important one.
Not only the aforementioned hidden costs, another external factor that may influence your trading performance could come from the inspiration from other successful traders. Find out and explore all about it in Trading Success Story.