In commodities you are typically charged a “round-turn” commission. This means that you will be charged once when you’re buying a commodity, but you won’t be charged again when you’re selling. However, you also have to pay the “market making spread” the market maker charges.

So you pay two fees each time you buy and sell a commodity.

A Single Fee vs. Two or Three Fees

However, in Spot Forex (aka. the FX or currency market), you typically pay only one fee when you buy. You don’t pay anything when you close out the order by selling it.

That was the best news I heard when I switched from stocks to currencies.

Fees are important because naturally, you want to pay the least for each trade so you can afford to invest more often. However, that’s just not possible if your trading account is eaten up by fees.

This is especially helpful to an active trader who may trade 20 to 100 times or so a month. Imagine the fees they save by trading Forex instead of stocks! It’s huge!

So how is this one fee applied in the Forex market? Like stock or commodity trades, you’re charged the “market making spread.” As I said, this spread is the difference between the buy and sell quote.

It’s fairly simple to figure out the spread before you enter a trade. This way you know exactly how much you’re paying to enter a particular position. You can figure out the spread by checking out the quote screen below of USD/JPY. That’s the U.S. dollar vs. the Japanese yen pair. Traders will refer to it as “dollar yen.”

The Spread = The Difference Between the Buy and Sell Quote

When this screen shot was taken above, the sell quote was 110.09 and the buy quote was 110.11. If you wanted to buy this pair, you’d pay the difference in these two prices, or the “spread.”

If I were to buy USD/JPY at that time, I would buy for 110.11. However, after I buy the pair, I’m concerned with the selling price. Because when the selling price gets to the level I want, I will then sell the pair.

But after I’ve bought the pair, the sell quote is still two “pips” below my buy price. So I would pay two “pips” worth to my broker (or “market maker”) to match up a seller that wanted to sell their USD/JPY position to me, the buyer.

What You’re Paying the Market Maker to Do

If I want to sell my USD/JPY pair, I don’t have to put an ad in a newspaper saying “Want to buy some USD/JPY?” or throw an ad on eBay…

Instead, the market maker goes out there and finds a seller who will buy that pair at this price. For this service, he or she charges me the spread as a fee. (In the example above, that would be “two pips.”)

Now once the sell quote climbs up to the price where I bought it, then I’m at breakeven on the trade. There’s no buy or sell commission involved, so all I had to make back was this “spread cost” to breakeven. That’s the beauty of the Forex market.

So once this pair “ticks up” three notches, I’m “one pip in the money” (that means “I’ve made one pip’s worth on my trade”) at that point and starting to make a profit on my position. Now we’re talking.

After all, I’m paying less fees so my trade doesn’t have to move as much for me to make money. If I had to pay both a buy and sell commission on each trade, then the pair would have to rise a whole lot more in value before I could post profits.

I’d have to hit a homerun on my trades to pay the significant trading costs. But no, I’ve only got this small spread to worry about. That’s something no other market can beat.

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What Do Pips Equal in Dollars?

I realize I’ve been talking about “pips” quite a bit up until now. A pip itself is the smallest increment a currency trade can move (four places beyond the decimal point). But let me take just a moment to explain what pips mean in dollars.

First thing you need to know: How much a pip is worth depends on what kind of account you have. As an individual, you can open what’s known as a standard or a mini-account with your market maker (or “Forex broker”).

If you have a mini-account, you’re taking a smaller position in a currency than in a standard account. A mini-account lets you control 10,000 units of currency, and a standard account allows 100,000 units of currency.

In other words, you get to control a lot of currency for a small fee. That’s what I love about this market.

So if a pair ends in U.S. dollars (ex. EUR/USD, GBP/USD, etc.) then one pip in a mini-account would be worth a US$1 each time the trade moves. Therefore a two pip spread would equal US$2. If you had a standard account, a pip for a USD pair would cost you US$10. (Or US$20 for this trade.)

This is how much your market maker would charge you to place the above trade. Your market maker would charge you once when you buy and nothing when you sell it back to the market.

However, some pairs don’t end in “USD.” So these have to be converted back to dollars to know what they are worth. Each broker will usually have a way of seeing pip costs on their website or on their trading software.

However, for the USD/JPY pair it’s even a bit less. One pip right now on each mini-lot is around 90 cents per pip of movement. So a 2 pip spread only costs you about US$1.80 in this case.

Tough Choice: $15 to Your Stock Broker or $2 to Your Forex Broker

If you were to go to some of the cheaper discount stock brokers, you would pay about US$7 to US$12 for your buy commission and the same once again for your sell commission.

That doesn’t even count the spread you must pay to purchase your stocks. So a single stock trade could cost you US$15-US$16 minimum in fees. (And that’s for a discount broker – many full-service brokers charge much more.)

However, to buy a single lot of USD/JPY, you pay US$1.80. Which would you rather have? Bingo – that’s why I trade Forex.

One final example: If you see that the spread is 3 pips then you know, generally, the cost of the trade is US$3. It could be a bit less per mini-lot.

Check with your Forex market maker and they can show you how to calculate pip costs on their website if you want to know more. But the big thing to remember is many pairs are US$1 a pip in a mini-account. These are the pairs that end in USD. MOST other pairs that don’t end in USD are actually worth less than a US$1 a pip in a mini-account.

As in any business, you want to keep your costs low so you can start earning profits faster. Investing is no different. So be a shrewd “cost manager” and choose currency trading that only charges you once.

Best Regards,
Sean

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Forex News 101

From Chuck Butler, President of World Markets at EverBank

What Happened:

Front and center this morning, you have to mention Trade Deficit. For June, the deficit narrowed from US$59.8 billion to US$56.8 billion, which looks good, right?

What I Say:

Well, you have to be careful what you wish for. This drop in the Trade Deficit pushed the dollar higher yesterday morning. This has me thinking. A stronger dollar will not play well with exports… And exports have been something short of amazing with the dollar being weak.

In fact, exports have accounted for the largest contribution to GDP in the past five quarters! (U.S. Consumer spending is drying up, so this is possible!) Add to that, everyone is getting goose bumps regarding a global slowdown.

If the world slows down, then it will prop up the dollar, then U.S. exports will slow even more!

You know, the fourth quarter 2007’s “revised” GDP came in at negative .2%. We were just getting started on the road to recession, folks… And now, just when U.S. consumers have their tax stimulus checks to spend to prop up GDP, the dollar gets strong, and exports take a ride on the slippery slope.

It’s all over now… Baby Blue…