What is the best type of trading cost? How would you know that you will get the best trading cost from a forex broker? Find out the answers below.
Every broker needs income to operate and continue their work. Even by offering many bonuses, free commission, or extremely low spreads, they are always able to get around to earn income from their traders.
That is why as a trader, you should not be easily consumed by those shiny offers without considering the realistic situation behind them. In every attractive offering, there is a cost and risk that you might gain from the broker.
That's why you need to set a time to choose brokers specifically by their trading costs.
In general, there are 4 steps to do it:
- Understand the types of trading costs
- Choose the spreads
- Consider the commissions
- Don't forget the extra costs.
In this article below, we will discuss them thoroughly.
1. Understand the Types of Trading Costs
Essentially, there are three types of commissions charged by a forex broker. There are 3 types of broker's trading costs:
- Fixed spreads
- Floating or variable spreads
At first glance, the fixed spreads might sound like the right choice because then you would know the exact cost to expect, and you wouldn't have to worry about the price changes in the forex market. If the broker uses a fixed spread, then the spread would likely stay in certain pips or ranges even if the price changes due to market volatility.
In contrast, floating or variable spreads can change according to the price movement. So you can expect the spread to change lower or higher than 2 pips.
In the third option, brokers may charge a commission fee to compensate raw or zero spreads, perhaps two-tenths of one pip, and then pass the fees to the liquidity providers. With this system, you can get a very tight spread that usually only applies to big players.
So in other words,
2. Choose Your Spreads: Fixed or Floating?
When it comes to choosing the right spread type, each trader is most likely to have a different answer.
Brokers with floating spreads usually have good connections to a number of liquidity providers and can offer their clients more competitive prices. Even after widening the spread to get bigger profits, brokers like this can still provide a more competitive spread compared to those with more limited LPs.
The drawback is, because it depends entirely on the market volatility, floating spreads can be beneficial or harmful for your trade. If the volatility is high, there is a possibility that you should pay way higher than expected. Therefore, if you choose variable spreads, you must be extra careful about the time you trade.
However, if you are a type of trader that prioritizes accuracy, fixed spreads might be the best choice because you can calculate the cost beforehand and expect little to no changes. Slippage, a condition where the order is executed at a different price, is something that you definitely want to avoid.
In the end, it would mostly come to these 2 rules:
- If you prioritize stability, then a fixed spread may be more suitable for you compared to a floating spread.
- If your strategy is best applied in low-spread conditions, choosing floating spreads might be the better solution.
3. Consider the Commission
Let's say you have chosen floating spreads and it turns out the broker accompanies it with commissions, you might reconsider and think "Is it worth the cost?"
In this case, it's best to check how much the commission is and make sure that it's not too much for you. Brokers like IC Markets and ThinkMarkets typically charge a commission of $3.5 per 1 standard lot traded on each side. So if you don't mind paying an additional $7 for every standard lot you trade, then choosing floating spreads would not become a problem.
In addition, it's worth noting that some brokers might even offer extra bonuses or services in exchange for the commission to attract more traders.
For instance, a broker may charge a commission of two-tenths of one pip or about $2.50 - $3 per 100,000 unit traded but offers unlimited access to a superior trading platform and a few other benefits.
So in this case, it may be worth paying a small commission. Just make sure that the services offered are useful and worth the cost.
4. Pay Attention to Other Forex Broker Costs
Apart from the three types of commissions mentioned above, there are also some hidden trading costs that traders often overlook
In some cases, the spread displayed on the broker's website is not entirely accurate because it does not show the real trade execution. Brokers might only show the best price for about five lots of transactions, while the truth is that the next lots' spreads are different.
Some brokers might also charge a funding cost, which you must pay when you deposit funds in your account. Usually, the cost depends on what payment method you use. Other than that, you should also be aware of brokers that charge negative swap rates for overnight positions.
Lastly, there may be some taxes charged by the government. If you reside in a country that considers forex trading profit as a taxable income, you need to pay attention to your profit accumulation by the end of the year.
There are 3 types of forex brokers' trading costs: fixed spread, floating spread, and commissions. In order to minimize unexpected losses, you should know your trading needs first before choosing those types of trading costs.
Keep in mind that brokers are business companies that need to gain income in order to operate, so even if their trading costs are really low or even free of charge, you should not believe that straightaway. It is possible that the broker actually charges hidden costs that you would only recognize after trading with them for some time.
More importantly, make sure to match the broker's services with your trading needs.
In the end, although it isn't the only factor that should determine the choice of your broker, trading costs aren't something that can be underestimated because they can be a burden and affect the whole trading experience, especially if you plan to trade from a small account.