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Trading As A Business And Its Cost

Any business has cost, trading is no exception. But surprisingly most of traders do not think about cost, or they totally ignore the cost, they focus on profit/loss instead. It is ok to focus on profit/loss for trading, as it makes no sense to engage trading at first place if no profit is expected.

However here I will not discuss loss control or making money etc, as that is a very big topic and everyone will have their own ways or opinions.

I would use a naïve but practical example to show how trading cost plays a role in this Business, if you agree that trading should be a serious business also. By the way trading should not be for fun, excitement or thrill.

Let's assume that one is trading S&P 500 e-mini future contract, which is very liquid and trading cost is comparably very low. We will have those trading cost.

a). Broker commission,

b). Bid ask spread,

c) future roll over cost (if you trade CFD or other instrument, other cost might incur also),

d) slippage cost if any.

Assume that S&P 500 index is now at 2000.

One S&P 500 e-mini future contract notional will be 2000*50 = 100,000.

To open and close the trade, conservatively I would estimate the trading cost will be 5bps (5pbs =0.05%). The transaction cost will be 0.05/100*100,000 = 50 for one contract.

Assume the trader has 100,000 USD as trading capital, with 5 times leverage, the trader buys 5 contracts, and the trading cost will be 5*50= 250.

If the trader is a so called "day trader" who will have one trade at least per day. The total trading cost will be 250* 250 = 62500(here I assume 250 trading days per year), relative to the trading capital; the trading cost per year will be 62.5%. If the trader leverage to 10 times, the trading cost will be 125% of total capital. That means the trader has to make 125% of the capital to breakeven.

Some might argue that for day traders, their profit will easily cover this cost. But can the day trader consistently earn 62.% or even 125% of capital year on year? Mostly not unless he is a genius or coming from future.

Profit or loss is uncertain, but trading cost is fixed. how to reduce the trading cost? Clearly there are two ways:

1. Reduce leverage.

2. Reduce trading frequency (stop being a day trader)