Knowing the transaction costs associated with your trading
When you begin trading, you’ll notice that you’re given a ‘bid’ (or ‘sell’) price and an ‘ask’ (or ‘buy’) price. The ‘bid’ is the price at which you sell the base currency, and the ‘ask’ is the price at which you buy the base currency. The difference between these two prices is what we call the spread.
When a trade is opened, there are always third parties who facilitate the opening and closing of that trade, like a bank or a liquidity provider. These third parties must make sure that there is an orderly flow of buy and sell orders, which means that they have to find a buyer for every seller and vice versa.
The third party is accepting the risk of a loss while facilitating the trade, thus the reason the third party will retain a part of each trade – that retained part is called the spread!
The spread itself is measured in ‘pips’, which is the smallest unit of price movement of a currency pair. So, the spread in the below example is 0.2 Pips.
To work out the cost of a trade itself (not including swaps, commissions etc.), you take the spread and pip value and multiply it by the number of lots that you’re trading:
Trade Cost = Spread X Trade Size X Pip Value
A trade you have opened has 1.2 pips spread. In this example, you’re trading with mini lots which are 10,000 base units.
The pip value is at $1, so the transaction cost is $1.20
As you’ve probably gathered, the bigger the trade, the larger your transaction costs will be!
Quite simply, swaps are an overnight interest charge that traders must pay to hold a position open overnight. When a trader wants to keep a position open, they will pay interest on the currency sold, and receive interest on the currency bought. So, the swaps are derived from the interest rates of the countries involved in the currency pair, whether the trader is going long or short and the current market conditions.