In Price Action Trading Strategy

There are a number of things that make a person a better trader, and several of those things have absolutely nothing to do with a person's ability to trade. Over the years, I have seen a number of wildly different scenarios – from money mangers charging huge on the front and / or backend to retail traders going with a broker that charges them extraordinarily high costs. Some people realize the high impact transaction costs have on them over the long run while others tend to sacrifice this knowledge for other things.

 

In the Professional Environment

Transaction costs are such a huge deal that they are commonly written about in college or university portfolio management classes (I know they were with mine) and analyzed in the corporate world with companies such as the Investment Technology Group specializing in detailed transaction cost analysis. There is no other way of describing this: transaction costs eat away at your P&L.  They will suck you dry like any other fees.

Below is a graph of simple, backtested hypothetical results of the same trading system. The top image shows the graph in a simulated environment, while the other shows actual results. Even from a rough example such as this it is easy to understand how drastically fees could affect your P&L.

Source: Aswath Damodaran

 

New Regulations Regarding FCM transparency

New regulations imposed by the NFA and CFTC last year have forced brokers to show their curve of profitable vs. unprofitable accounts. From a retail perspective, we can start to see some things unfold which has us curiously wondering about the direct impact what these brokers are charging for spreads has to do with their clients making money.

The one that has been consistently topping this list is, no surprise, Oanda, who from our knowledge has some of the cheapest commissions offered to the retail world. They might not have the cheapest spread, but they are also not charging on the backend for lot size, which many ECN brokers have taken a fancy to do doing in recent years.

2010 Q4 Results

Source:  ForexMagnates

This black-and-white example could indeed be attributed to other things, but as we have always known, Oanda tends to carry and open book in terms of what it is that they do and how they operate. It is one of their best selling points (clearly from their perspective) just casually looking through their website.

Other brokers that fall to the bottom of this list, we won't comment on, but you can do the math. They start to get mixed around the midway point but that, of course could be simply contributed to luck of the pot in terms of who they get for clients.

 

An Example

Here's how badly a steep charge could affect you:

Let's assume you only trade with 1 standard lot, or $10 per pip where USD is the secondary currency.

– Broker A charges 2.5 pips on EUR/USD, or $25 per trade

– Broker B charges 1.5 pips on EUR/USD, or $15 per trade

Now let's assume you make 15 trades per week:

– At Broker A that would be a total of $375

– At Broker B that would be a total of $225

The difference between the two is of course, $150 in additional commissions given to the broker charging higher costs per week. Assuming you maintained consistency throughout the year and traded 15 times every week, just by having a more expensive broker you would be losing $7,800 in pure cash. And where is that money going?  Someone else's retirement account…not yours.

Considering the fact that many traders tend to overleverage themselves in this industry it is no wonder why so many get burnt when you take a factor as heavy as this into play. And considering the paperwork and hassle that goes into opening a trading account it is also no wonder why many people never make the switch once they realize that something is terribly wrong.

WHY do people opt for brokers that generally offer higher spreads in the first place?

1. Bells and whistles. People don't want to pay for charting software or some other service so they go with a broker that will offer it for “free”. Let's assume in the example above your charting service was $100 per month, or $1,200 per year. That is a heck of a lot better than paying $7,800 to your broker on costs. It is a matter of perspective.
2. Inexperience. You haven't been around too long so you pop for the broker that just advertises, or gets in your face the most.  Nice website….must be good….ehe?

 

Markups

A term very well known to your market making broker, but perhaps not you is “mark up”. Your broker essentially buys at a specified price from a dealer, and gives you another. The difference between these two numbers in the markup. Depending on liquidity and any other general rules your broker has chosen for themselves, this is yet another factor that could affect your execution.

One thing I would always recommend is to simply compare the price feeds from broker to broker, side by side, and see that you are truly getting what you deserve. If there is a way to increase any form of unfair advantage, this is certainly one of them, but then again is it much different than any other business that buys wholesale and sells retail?  Your emotions might take over the answer to that question.

 

Other Factors

There are other factors, of course, that come into play and a while ago we outlined many of them in our 12 Considerations for Selecting an FX Broker. Just be aware that execution is also a very relevant part of this list, as is a watchful eye through government regulation, etc.   Spreads certainty aren't the end of the story when it comes to picking a broker that is right for you.

As common sense as much of this might be, it is a simple wake-up call in terms of your costs.  As a call to action: if you are paying high fees and you know it, we urge you to do something about it…..fast.  You can't go wrong with exercising some good old common sense.

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Showing 15 comments
  • Arturas Sadauskas
    Reply

    Details matter heh 🙂

    Why don’t they have Saxo? Deutsche? etc?

    probably they aren’t US based..

  • investwiz
    Reply

    Hi Steve, good article. About Onada, I don’t have an account with them yet, but their customer review is not good. Have you ever used their platform, and if yes whats been your overall experience about their platform/service/slippage etc?

    Thanks

    • Steve W.
      Reply

      Hi there, A long time ago yes but I never really had any complaints. Others I am sure will have an opinion but for me they were o.k.

      • bagz
        Reply

        I’ve been trading with oanda now for … at least 2 years. Customer service has been fair… always been able to reach them quickly, even when they’ve had platform problems. They don’t send outage notifications, which annoys me.. you have to discover it for yourself.

        Order execution is very good.. being impulsive with market orders during news events can be *hurtful* however. During normal market action, I’ve found market orders to be filled well, with very little price slippage (although I mostly trade with limit orders).

        Interest earned is dependent on home currency (nominated on the account). Mine is AUD so i get market rate. Won’t make you rich, but at least the idle money is earning something.

        Spreads are usually pretty good, but they can stretch a bit during high volatility. ie euro might jump from .9 to 1.4-1.9 if theres something exciting going on.

        2 things I didn’t like about this company were their Java based charts (very unstable, and clunky chart wise, but fine for order entries), and spread blowouts (5 – 15pip spread on just about everything) during big news.

        They offer MT4 now, so you can dodge their Java stuff.. and if you don’t trade news (I don’t) the spread explosion isn’t a problem…. just gotta keep an eye on the calendar and ensure your stop isn’t too tight during a big calendar item.

        I still use them, and would recommend them.

        • boosy
          Reply

          I trade with Oanda as well, good execution and not much slippage. Yes the spreads widen round news time but I never understand the obsession with this-don’t trade the news!!
          Can highly recommend-charts are clunky, but I use MT4 + their indicators for charting, then trade off Oanda for execution.
          One bonus, you can trade ‘on the charts’ with Oanda-so instead of time consuming manual/typing input, you can actually just click on the charts, mover stop levels up and down etc.
          If only PRT charts teamed up with Oanda….

  • Arturas
    Reply

    Another reason why Oanda has higher prof. ratio on accounts is that they provide Money Management services. So they attract more pro traders with their customers… and the customers don’t trade, their accounts are just being managed a pro.

    • David
      Reply

      In a recent article the did some research why Oanda beat the other brokers in profitability of there customers. The main reason is that Oanda pays interest on the trading accounts. So all accounts that are not active have been counted as if they made a profit.

      • Steve W.
        Reply

        Ah….nice pick. Very good point I remember this was the case. Yes just basic $ accts get it daily at the going rate, which in this market remains bottom of the barrel less AUD but still something.

  • Alvin Co
    Reply

    I am a noob and Oanda was the first MM I used to demo with that I got to like though I had misgivings opening an account with them because of the tedious paper work and you can only withdraw through bank wire after faxing a form. I am eyeing FXpro because of high leverage, micro lots, they accept moneybookers for deposit and withdraw funds with just an email, the only thing that creeps me about them is that they’re in Cyprus and sponsoring 2 football teams in English premiere league which at the back of my mind begging to know if they are a stable company or spending a lot of money marketing then gone bankrupt the following day. It would help me a lot if you have any experience with them or you guys could recommend a broker. TIA

    • Steve W.
      Reply

      Hi Alvin and welcome. The paperwork they are making you sill out will be identical to any broker regulated by the NFA/CFTC. All of the items on those docs are required, so it won’t be any different with any other broker regulated by the same entities, but its worth it. For the leverage, same deal, 50:1 is max you’ll get with a US entity. Personally that is way more than needed for tolerable risk and everything that goes with it. Depending on where you live it will vary where you can open an account but I would look at the majors that just have good regulatory oversight.

  • Mark W>
    Reply

    Hi Steve,
    MB Trading, who have pretty tight spreads and advanced order types, but also charge high-ish commissions instead of putting their fee into the spread, has recently started paying traders for providing liquidity by the use of limit orders. So, for traders who can avoid “implusive” entries and exits, and plan their trades, this will reduce trading costs quite substantially. MB’s traders can also hit each others order directly in the quote, further reducing the need to go to the interbank for liquidity. Net result will be substantially reduced trading costs for some types of traders over the traditional deal desks.

    • Steve W.
      Reply

      I heard about this in terms of the limit orders. I am not too familiar with it though (regarding costs, etc.) but sounds like they’re pressing for a good incentive here.

  • Sam
    Reply

    MBT now pays for limit orders so this list is bogus.

    Been using them for a year now and am pretty happy, especially since they are ECN

    • Steve W.
      Reply

      This is a Q4 ’10 list and it will be interesting to see the Q1 ’11 results all tallied up. I know they have been paying but how much of an impact that will have in terms of P&L in traders accounts we’ve yet to see. Hey at least they’re thinking out of the box on this one, gotta give ’em credit for that.

      • vlad
        Reply

        I was a moron who thought that you can scalp on 5min charts 1 month after you saw a chart for the 1st time in your life. Obviously, for such a setup, spread/commission is vital(at least that I managed to figure out in the 1st day).

        you won’t pay the commission; you’ll get paid(half of the commission). Great.

        but you’ll still pay the spread. ALWAYS.

        What I mean – between 5-6pm EST(it’s midnight here, and I prefer working at night) – you can have your short at ask for 10 mins. without ever being hit and when you open what they provide as “market depth” analyzer for forex, it’ll show that all the transactions are performed at bid. Only when your limit is at bid you’ll be filled; somehow noone will buy “at market” from you. EVER.

        that being said(obviously news not withstanding, I’m not that crazy) I was slipped a couple of times for 2-3 pips in extremely agitated markets; so, great execution. But still you pay the spread 🙂

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