forex trading cost traps

Forex Trading: Beware the Cost Traps

Today online brokers make currency trading easy and widely accessible. But what does forex trading really cost and how can you avoid nasty surprises? This guide by moneyland.ch answers those questions.

As with any other business, you need to count the exact costs right from the start, regardless of whether you choose a Swiss-based or an international forex broker. The fees and charges used by Swiss brokers and banks generally follow international norms.

The most notable expense is posed by the spread, which is included in rates. Unlike trading in shares, forex trading doesn’t typically involve fixed costs in the form of brokerage fees, but there are exceptions. For example, Saxo Bank charges a fee of $10 (US) per trade for smaller forex trades.

Besides the spread and possible brokerage fees, trades might be subject to additional fees for swaps or supplementary services, depending on your broker and trading terms and conditions. As in stock trading, inactivity fees are common in currency trading: If you don’t perform any trades within a certain time-frame, you have to pay a fee. Saxo Bank charges an inactivity fee of 100 francs for every 6 months of inactivity.

The Spread Is Your Biggest Expense

So-called spreads are the biggest expense in forex trading. The bid-ask spread, commonly referred to as the “spread”, is the difference between the current buying and selling price of a currency, and only applies to completed transactions.

How wide (expensive) or narrow (cheap) a spread will be depends largely on the currencies being traded. Apart from the currency, factors like a trades volume, your equity in an account and which broker you work with also affect the size of a spread.

Spreads in relation to volume and equity

The exact width of a spread often depends on the amounts being traded. The rule of thumb here is: The higher the amount of currency being traded, the wider the spread.

The portion of a trade that you finance yourself (your equity in the trade) will also affect the cost of the spread.

The rule of thumb here is: The higher your equity in a forex trade, the narrower the spread, and the lower your cost will be. Swissquote, for example, offers 3 different spreads for each set of currencies depending on how much equity you bring to the trade.

Swiss forex brokers compared

Forex fees vary between trading platforms and brokers. That’s why it’s worth comparing different forex brokers before opening an account. Bear in mind that costs vary depending on the currencies you trade.

Example: Let’s say you are primarily interested in trading between euros and U.S. dollars. Swissquote had EUR/USD offers with spreads ranging from 1.8 pips (when your equity is US$25,000 or more) to 4.0 pips (with equity of US$10,000 or less) at the time this article was published.

At Saxo Bank, the spread for the same EUR/USD currency pair on the same date sat at around 2 pips. If your equity in the trade were low, you could pay up to twice as much at Swissquote. On the other hand, Swissquote would work out somewhat cheaper if you had a lot of equity to bring to the trade.

Beware of variable spreads

Be aware that forex brokers may adapt the spread in the event of high market volatility or illiquidity. If they do, spreads can suddenly widen, and the cost of trading can climb substantially. This may happen shortly after the publishing of market relevant information by national banks or other major financial institutions, for example. Spreads may also be widened shortly after the opening or closing of major stock exchanges.

Spreads: What are pips?

Forex spreads are measured in pips. A pip generally represents the last digit in a given rate. The difference between the buying and the selling rate makes up the brokers commission.

Example: Suppose you want to buy euros and pay in Swiss francs, because you believe that the euro will gain in value against the Swiss franc over a certain period of time.

You want to trade the EUR/CHF currency pair.

A broker is offering a rate of 0.9048 (bid) and 0.9051 (ask). The difference between the EUR/CHF bid and ask prices comes to 0.0003, or 3 pips.

If you bought 10,000 Swiss francs’ worth of euros (“go long” in trading jargon), you would get 9051 euro (the “ask” rate). But because the spread for this trade consists of 3 pips, you only receive 9048 euro (the “bid” rate). So you would pay 3 euros in spread fees for your trade.

Fees for leveraged forex trading

Because fluctuations in forex rates are normally small, traders typically make use of leverage to multiply gains. Leveraged trades can greatly increase your profits, but also greatly increase your risk. Saxo Bank, for example, offers forex trades with leverage as high as 1:100.

When you make use of leverage, you are in really taking out a loan from your broker which you are simultaneously investing in a forex trade. To reduce risk, forex brokers require a security deposit (also called a margin).

If losses accumulate to the point that the margin is no longer sufficient to cover them, you will normally receive a margin call. When that happens, you as the trader will have two choices: either you cough up more money and extend the margin, or you close the position and take the losses.

If your trades are all successful, which is a best-case scenario, making use of leverage won’t cost you a thing. However, if you hold long positions overnight or over the weekend, you may accumulate interest charges. In trading jargon these are known as rollover interest.

As with most other loan types, the cost of financing leverage follows an annual interest rate and is calculated based on the number of days or nights for which you hold the loan. Because of the high cost of financing, the majority of forex trades are performed as intraday-trades, with trades being opened and closed on the same day.

Extra fees for supplementary services

Brokers often provide supplementary services, and you can choose to use (and pay) for these services, or not to. These supplementary services may include news services, research data subscriptions or market predictions.

Other costs you may incur when trading forex include fees for tax statements, cash withdrawals, and phone calls.

More information:
Forex calculator: profits and losses
Forex calculator: position size
Forex calculator: stop loss & take profit
Forex pip calculator
Swiss trading comparison
Forex trading in Switzerland

About Moneyland Magazine

The moneyland.ch magazine provides accurate, unbiased information on topics related to finance and money. In addition to research and expert interviews, the magazine contains numerous financial guides.