Forex Trading Costs

Costs Associated With Forex Trading Are:

1. Spread (which is often charged in lieu of a direct commission)
2. Rollover (associated with holding trades overnight)

Spread Fees

The main method that a forex broker will use to make money is by having a bid/ask spread. The broker will offer a variety of currency pairs, and the investor can use his currency to buy into any of the currencies that the broker holds relative to the current spreads. The broker will sell you the currency you are interested in at a price higher relative to the price at which he will buy back the same currency from you for your original currency: this is the method that he uses to ensure he is making a profit. This spread allows the broker to “buy low” and “sell high.” Thus as an investor, one should try to find a broker whose spreads, on average, tend to be quite small.

Rollover Fees

Another type of fee is the rollover fee. This is somewhat of a different concept because sometimes, instead of having to pay the rollover fee, the investor is credited this sum of money. Rollover fees apply when a forex position is enacted after all the major markets have closed. Since the investor typically waits a few hours to receive the destination currency, the interest that he could otherwise have obtained by putting that currency in his bank account is lost. Thus rollover fees constitute the difference between the interest rates of the bought currency and the sold currency, compounded appropriately. If the investor buys into the currency with the higher interest rate, he will be paid the appropriate rollover amount at the start of the next trading session. If he buys into the currency with the lower interest rate, he gets charged the appropriate rollover amount.

High Leverage and Margin

Margin trading also provides another type of cost that is even more prevalent in forex trading than it is in stock trading. Forex trading typically requires a very high amount of leverage because of the size minimums placed on certain types of forex trades. Traders who do not have enough cash must trade via financing. Typically, forex brokers allow leverage ratios of up to 100:1; this means that an investor must only own 1 dollar out of every 100 invested. Even more risky is the fact that most forex traders do not even have to okay their decisions to borrow equity from their brokers: the necessary dollar amounts are automatically transferred when needed.