Beginner’s Guide: Post 28
Alright, let’s shift gears a bit from the internal battle of discipline (The Power of Discipline: Sticking to Your Trading Plan) to something more tangible but just as important for your bottom line: the costs of actually making trades.
You’ve picked out a broker (Choosing Your First Day Trading Broker), you understand their platform (Introduction to Day Trading Platforms), and you’re maybe even practicing placing orders. But have you stopped to think about how much each of those clicks actually costs you? Because believe me, trading isn’t free, and these costs can nibble away at your profits – or add to your losses – significantly, especially if you’re trading frequently like a day trader often does. Ignoring these costs is like running a business without knowing your overhead – not a recipe for success!
The Main Culprits: Commissions
This is the one most people think of first. A commission is simply the fee your broker charges you for doing their job – executing your buy or sell order. How they charge it can vary:
- Per-Share Commission: This is common for stock trading, especially with brokers geared towards active traders. You might pay a fraction of a cent, maybe half a cent, or a few cents, for every single share you trade. Sounds tiny, right? But if you trade 1000 shares in and 1000 shares out, even half a cent per share adds up to $10 for the round trip!
- Per-Trade / Flat-Fee Commission: Sometimes, especially with options or futures, or maybe certain account types, you pay a fixed dollar amount for each trade (or “contract”), regardless of how many shares are involved.
- The “Zero Commission” Craze: You see this advertised everywhere now, right? “Trade Stocks Commission-Free!” Sounds great, but hold on. While the explicit commission might be zero, these brokers still need to make money somehow! Often, they do it through something called Payment for Order Flow (PFOF), where they route your orders to big trading firms who pay them for the privilege (those firms then try to profit from the tiny price differences). Does it directly cost you more? Maybe not obviously, but it can sometimes lead to slightly less optimal prices (execution) compared to brokers who charge commissions directly. Plus, “zero commission” brokers often still charge fees for other things, so always read the fine print!
The Sneaky Cost: The Bid-Ask Spread
Okay, this one is less obvious than a commission fee, but it’s a cost on every single trade, no matter your broker. Remember when we talked about basic terms (25+ Essential Terms Beginners MUST Know)?
- The Bid price is the highest price someone is currently willing to buy at.
- The Ask price (or Offer) is the lowest price someone is currently willing to sell at.
- There’s always a difference between these two – that difference is the Bid-Ask Spread.
Why is it a cost? Because if you want to buy right now using a market order, you’ll almost always pay the higher Ask price. If you want to sell right now with a market order, you’ll almost always get the lower Bid price. You instantly cross the spread.
- Example: The price is quoted as Bid $10.00 / Ask $10.01. The spread is $0.01. If you buy at market, you pay $10.01. If you immediately sold at market, you’d only get $10.00. You instantly “lost” that 1 cent spread.
In very liquid, active stocks (What is Liquidity and Volume?), the spread might only be a penny, which isn’t too bad. But in less liquid stocks, the spread could be 5 cents, 10 cents, or even more! That’s a much bigger hurdle your trade needs to overcome just to get back to break-even.
Don’t Forget the Other Fees!
Besides commissions and spreads, keep an eye out for other potential charges:
- Platform Fees: Some brokers charge a monthly fee for using their more advanced trading platforms, especially if you don’t trade enough volume.
- Market Data Fees: Getting real-time, detailed market data (like that Level 2 data we mentioned briefly in Post 10) often costs extra per month. Exchanges charge brokers for this data, and they often pass the cost along.
- Inactivity Fees: Some brokers charge you if you don’t make a certain number of trades within a month or quarter.
- Other Annoyances: Fees for wire transfers, account transfers, paper statements, etc.
Always read your broker’s full fee schedule! Know what you might be charged for.
How This All Adds Up (The Profitability Pinch)
Think about it: every single time you enter and exit a trade, you’re likely paying a commission (maybe) AND you’re definitely crossing the bid-ask spread. Plus maybe data or platform fees.
- These costs directly reduce your net profit on winning trades. A $50 winner might only be $40 net after costs.
- They also increase your net loss on losing trades. A $30 planned stop-loss might end up being a $40 net loss after costs.
- Crucially, this means you need to make more on your winners just to cover the costs of all your trades (winners and losers). It effectively raises the bar for profitability and might mean you need a slightly higher win rate or a better Risk/Reward ratio than you initially thought.
Factoring Costs In
So what do you do?
- Be Aware: Know your broker’s commission structure inside out. Pay attention to the typical spreads on the assets you trade. Understand any potential data or platform fees.
- Mentally Adjust: When you’re evaluating a trade’s potential Risk/Reward, mentally factor in the estimated round-trip costs. Is that 1:2 R/R still attractive after accounting for $10 in costs? Maybe, maybe not.
- Choose Wisely: Consider the costs when choosing a broker, especially balancing commission rates against potential platform quality or execution speed.
Wrapping Up: Know Your Expenses!
Trading costs – commissions, spreads, and other fees – are a real and unavoidable part of the business. They might seem small individually, but for an active day trader, they add up quickly and directly impact your bottom line.
The key takeaway? Don’t ignore these costs! Understand exactly how and what your broker charges you. Be aware of the bid-ask spread. Factor these expenses into your analysis and your expectations about profitability. Being cost-aware is just part of trading smart.
What’s Next? Another Practicality: Taxes
Okay, you’re aware of the costs your broker charges. But what about when you actually start making profits? There’s another entity waiting for its slice of the pie: the tax man! Understanding the basics of how trading profits are taxed is another essential piece of the puzzle.
Let’s get a very basic introduction (with big disclaimers!) to how taxes might affect your trading in Post 29: Day Trading and Taxes: What Beginners Need to Be Aware Of
