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.
Most traders are interested in forex trading in order to gain profits. Compared to other financial markets, the forex market is quite unique because it has unlimited potentials in profits. Even so, it is worth noting that just like any other investment, there is always a cost to pay.
Forex brokers commonly charge trading costs in exchange for access to the market and other facilities that could help traders to trade better and easier. With the emergence of many new brokers, they have become more and more competitive with their offers. For this reason, all forex brokers are competing against each other to offer the lowest trading cost and provide the most favorable trading conditions. To attract more clients, some promote low spreads and even claim to be free of commission charges.
From a trader's perspective, those offers must appear incredibly attractive; it must be really convenient to trade without worrying about additional trading costs. However, no matter how tempting those offers are, keep in mind that brokers are business companies, not charity organizations. 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. In order to minimize the unexpected losses, you should know the criteria of a trusted broker with realistic and affordable trading costs. In this article, we will further discuss types of trading costs and how to choose the right broker based on its trading costs.
3 Types of Forex Broker's Trading Costs
Essentially, there are three types of commissions charged by a forex broker. Some brokers offer fixed spread, others offer floating or variable spread, while the rest charges commissions. So, which type is the best choice?
Before discussing the answer, we should know what spread is and how it works. Basically, spread is the difference between the bid price and the ask price. Bid price refers to the price traders receive for selling a currency, while the Ask price refers to the price traders must pay to buy a currency.
As for the broker, spread is one of their biggest sources of income. The value of the spread can be seen when choosing a currency pair to trade. So let's say the bid/ask value for the EUR/USD pair is 1.2612/12614, it means the spread value is 2 pips.
So which spread type is the most recommended? At first glance, the fixed spread 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 from the example above, the spread will always stay in 2 pips even if the price changes due to market volatility.
In contrast, floating or variable spread can change according to the price movement. So you can expect the spread to change lower or higher than 2 pips. Because it entirely depends on the market volatility, floating spread can either 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 end up choosing variable spread, you must be extra careful about the time you trade.
In the third option, brokers may charge a very low commission fee, 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, brokers can lower their spreads but charge a small commission instead. Some brokers might even offer extra bonuses or services in exchange for the commission to attract more traders.
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 that 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.
Pay Attention to What You Need
When it comes to choosing the right broker, each trader is most likely to have a different answer. Not all brokers are equal, so each has its own unique features and offers various facilities. That is why not all brokers are suitable for all traders. Every trader has their own trading needs, strategy, and preferences. You should weigh on all of the options and pick the one that supports your trading the most.
You can see the different levels in which a broker provides their service. Even regarding the same currency pair, the price offered by a broker is not always the same with another due to the different liquidity providers that they use. Remember that the forex market is an over-the-counter market where big banks and big brokers play the role of liquidity providers (LPs). Retail brokers work as price aggregators offering a wide range of trading services to clients while simultaneously bridge the clients and the market. Therefore, the broker's capability of maintaining their connection with the liquidity provider has a pivotal role in the way they set up their trading costs.
Brokers with good connections to a number of liquidity providers 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. So if you find a broker that could connect to many liquidity providers with competitive spreads, then that would be the ideal choice to look for.
However, if you are a type of trader that prioritizes accuracy, fixed spread 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.
See also: The Danger of Forex Broker Slippage
In the case of a commission, it is best that you should weigh the commission and the facilities offered. Usually, brokers would charge a commission in exchange for special services. 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. Make sure that the services offered are useful and worth the cost.
From the explanation above, we can conclude that trading cost is one of the crucial aspects that should be considered when picking a broker. Each broker offers a different set of services and charges its traders in various ways. That means, before you register with a broker, make sure to check their trading conditions and read their policies carefully.
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 charge 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. If you prioritize stability, then a fixed spread may be more suitable for you compared to a floating spread. In contrast, if you need to use sophisticated tools and indicators to trade, you can try searching for brokers that would charge commissions in exchange for access to premium platforms or other distinguishing features.
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 it can be a burden and affect the whole trading experience, especially if you plan to trade from a small account.