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The Cost of Trading Forex
Written by: PaxForex analytics dept - Friday, 20 November 2015 0 comments
As is widely known, if one participates in the Equity or Futures markets, there is always a commission charge for taking a trade. This charge pays the broker for allowing the position to be taken in the first place. However, when it comes to forex trading the situation is slightly different in that traders do not pay a direct commission to the firm, but rather are faced with a spread on a currency pair which they choose to trade.
For every trade that you place, you will have to pay a certain amount in costs or commissions for each trade that you place with a broker. These costs vary from broker to broker, but they are usually a relatively low amount. These are usually the only cost of trading that you are likely to incur. This may sound like a simple enough process, but many traders overlook these costs of trading and thus underestimate the challenges to generate a long-term profit.
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.
At the end of each trading day (5:00 pm Eastern time), positions held in your account may be subject to a charge called a “holding cost”. The holding cost can be positive or negative depending on the direction of your position and the applicable holding rate. Holding rates for forex are based on the TomNext (Tomorrow to Next Day) rate in the underlying market for the currency pair and are expressed as an annual percentage. Buy position holding rate = TomNext Rate % - 1% and sell position holding rate = TomNext Rate % + 1%.
Different rates are quoted for buy and sell positions and are actively traded between banks. TomNext rates in the underlying market are based on the interest rate differential between the two currencies. As a general rule, if the interest rate of the first named currency is higher than the second named currency in the pair (subject to the 1% adjustment detailed above), and you hold a buy position, the holding cost will be credited to your account. Conversely if you hold a sell position in this scenario, the holding cost will be debited from your account.