Active traders ply their craft because they are confident that they can pull money out of the markets. Being profitable at trading requires having a mindset that places a heavy emphasis on money management, a robust Trading Platform, and risk mitigation. It is not enough to have knowledge of the latest and most sophisticated trading systems. To survive in the business, today’s trader needs to have an intuitive understanding of asset allocation and a keen sense of scale in terms of position size. Ultimately, maintaining a sustainable career in trading involves managing a number of factors, and these factors include the management of transaction costs.
Investing and market speculation involves initiating a strategy designed to extract profits from the capital markets in the form of interest income or capital gains. These strategies demand a different level of commitment from the trader in terms of monitoring and assessing open market positions. In trading, profit expectations are very commonly commensurate with the level of risk a trader assumes. In the business of trading, most market participants understand that the most aggressive trading strategies tend to be the riskiest. Trading losses eat into profits and are part of the cost of doing business. Capital losses are not the only cost active traders have to contend with. Apart from losses, the vast majority of traders pay commissions, fees, and transaction costs associated with buying and selling the various assets they trade. For some markets, these costs are significant and may represent the difference between a profit and a loss.
Transaction cost analysis is an integral part of the process of generating effective order execution strategies. Superior order execution strategies will in almost every case bring about better portfolio performance through a reduction in trading expenses. The asset class a trader chooses to work with determines which set of transaction costs apply to any given trading strategy. Although there are many different trading vehicles, most traders limit their choices to just a few. The most popular of these are stocks, bonds, options, commodity futures, and foreign currency (FOREX). The largest and most important institutional investment firms care about transaction costs. Individual traders and investors should also care. To this end important information concerning these transaction costs together with suggestions on how to effectively attenuate them is presented in the below three sections of this material.
Equities and Fixed Income
The practice of day trading is most often associated with the asset class that includes common stocks. Most day traders do indeed try to make their living buying and selling stocks. The truth is that anyone with an equities trading account is eligible to trade fixed income securities if they want to, and there are several advantages to doing so. Unlike listed stocks, most bonds do not trade on any organized exchange. They are held in inventory by market makers who buy and sell them privately outside the purview of the brokerage community. Where there is no broker, there are no brokerage fees. Traders and investors comfortable with buying and selling bonds can trade them as often as they like commission-free. Learning how to trade corporate bonds is one way to save on commissions that lower overall transaction costs within a portfolio. Bond trading offers other advantages. Holders of fixed-income instruments earn interest every day that they own them. Although many bond traders hope for quick capital gains, they can enjoy the satisfaction of getting paid to wait if the trade they entered into does not pay off as quickly as anticipated.
The best way of reducing transaction costs in an equities trading account is to focus first on the obvious issue –brokerage house commissions. Commissions vary widely between firms, and it pays to comparison shop. Beyond comparing commission rates, it is beneficial to know that some brokerage firms offer 100 or more free trades with every new account. Opening a supplementary account with a firm that offers a significant number of free trades is another way for the trader to shrink transaction costs with minimal effort. A novel way of saving on trading commissions is to do away with them completely. There are stock brokerage firms that offer cash management style accounts. Such accounts require a relatively high opening balance, and they frequently come with fixed annual or quarterly fees, but they do have advantages. One of these is that account holder can trade as often as they like with zero commissions. Whether this type of arrangement works for a certain individual depends on how often they trade, and the fees they incur maintaining this kind of account.
One more way of cutting transaction costs in a stock trading account is to take advantage of Exchange Trade Funds (ETFs) sponsored by the brokerage firm that administers the account. ETFs are securities that trade like stocks and are generally subject to the same fees and commissions as stocks. Some brokers offer their clients the opportunity to trade in and out of EFTs that they sponsor free of commissions. They do this for promotional reasons. All ETF sponsors like to see increased trading volumes in the new issues that they launch. They make this happen by encouraging their own clients to help generate buzz for a product by letting customers trade the instrument for free. If an investor’s overall trading strategy is consistent with the characteristics of the ETF, then there is no good reason not to at least try this method.
Hidden Value of Stock Options
Traders and investors that are comfortable using high degree leverage can save money on trading costs by doing at least some of their speculation in the options and commodity futures markets. With certain brokerage firms, commissions for equity and index option trades compare favorably to the commissions charged on stock trades. The benefit of this commission structure is generally more meaningful when trading large lot sizes or when engaging in multi-option spread trades.