It’s important to thoroughly understand the cost of each trade you make. Any money that you spend opening or closing a trade order comes directly out of the equity in your account. There are three types of trading costs: the commission, the spread, and slippage.
The Commission: Some brokers charge commission, while others do not. Out of the three trading costs, it is the most transparent and consistent cost. For basic retail FX trading, the commission rate is typically the same each time you open a trade order no matter which currency pair you are trading. The rate is usually based on volume. (E.g. $10 USD per 1 standard lot traded in MetaTrader4.)
The Spread: This trading cost is what traders focus most on. Most spreads are dynamic, which means they vary based on liquidity in the market. Typically the spread will fluctuate slightly but stay within a tight range. The exception to this is when there is a “news event.” Examples of this include: a central bank policy announcement, economic data being released, and unexpected exogenous events such as Japan’s nuclear reactor in Fukushima being struck by a tidal wave. When a news event occurs, the spread can increase 10 to 30 times its normal width. It’s important to be very careful trading such events, as traders usually lose a lot of money due to abnormally large spreads and amounts of slippage.
Slippage: Traders typically place most of their focus on the spread, while largely ignoring slippage unless they receive a particularly large amount of slippage when one of their trade orders is filled or unless the slippage is blatantly obvious. (For example, when one of their trade orders was filled at a price which does not appear on their trading chart.) However, some brokers regularly slip traders very small amounts on every trade order and often times most traders will not realize that they are losing these very small amounts on each trade. Traders need to realize that most Brokers have complex dealing software that allows them to sneak in slippage using a variety of methods.
Note: Most traders that usually check to see what spread and slippage they receive on a trade order typically do so when the trade order is opened more often then when the trade order is closed. Brokers know this, so they will typically try and hide small extra slippage using dealing software when the order is closed versus when it is opened. If you trade on MetaTrader4, there are Expert Advisors (EAs) that you can install and run that will keep track of the (actual) spread and slippage on every trade you make.
So remember, your Trading Costs = Commission + Spread + Slippage. Keep track of your costs and add them up to figure out how competitive your broker’s trading costs actually are!
