Sunday, April 10, 2011

Lesson No 1 - Cost of Trading

The reason why 90% of the traders are losing money is because trading is a NEGATIVE, NEGATIVE sum game.

With $100 on the table that 90% of these traders lose money, how much will the 10% make? I asked a fellow trader this question, and we both felt that probably only half the amount or just $50. (Just our opinion) The other $50 disappear into the black hole of the system known as cost of trading.

All form of trading involve cost to facilitate the transaction whether you make or lose money. Rightly so because we need to pay for the services provided to ensure that the transaction is in order, safe and legal.

Traders even need to pay the government tax upfront in the form of 7% GST on the comm, no running away. For professional traders, they have to declare their profits which is subjected to taxes while they can't claim a penny if they lose money the following year except carrying the losses forward. Thus, the negative negative sum game.

Some gains are considered capital gain if taken in as an investment under their personal name. It's a grey area whether one derive this income solely from trading or trading as a part timer. Best to check with the acccountant if one is making lots of money.

Understanding the cost of trading is important for a trader who should treat trading as a business.

Let's look at the transaction cost of the various instruments.

1. Property - Basically for long term investors, 1% comm for the agent, stamp duty, valuation fee and lawyer's fee making it one of the most expensive in term of transaction cost. With capital gain tax and additional stamp duty thrown in for profits made within a year, only very savvy property specuvestors having good connections with developers and inside information should flip and trade.

One major upside on property investment is the depreciating value of our money and the limited supply of land in major cities. Thus, it is one of the easiest form of long term investment, it will always go up in the long run, no worries about mismanagement compared to listed companies.

The downside of property investment is liquidity especially when the market is down with transaction taking months to complete. Sellers might be squeezed to get out if there is an urgent need for cash.

2. Stocks - Cost of trading stocks have come down tremendously over the years but still the comm from trading Singapore stocks range from 0.4% to 0.25% for retail customers. It's still quite hefty but very liquid with narrow spreads and most traders treating profits as capital gain. Professional stock traders are registered with the Stock Exchanges paying yearly membership fees with comm below 0.1% but paying taxes on their profits.

3. ETFs, CFDs and Warrants - I'm not too sure about the comm structure but I'm sure it won't be cheaper than stocks with plenty of hidden costs factor into the prices by the banks that issue them and kiss your investment goodbye if these banks fail like Lehman Brothers.

4. Forex - "No comm, the best instrument to trade", claimed a very ignorant trader brain washed by some Forex course that he had taken. In actual fact, the spread between the bid and ask price is the comm for the brokers. It's very much cheaper now to trade Forex as the Euro/US$ pair spread sometimes narrow down to 1 pip which is US$10 for a round turn of buying and selling US$100k worth of currency. While some not so liquid currency pairs have spread of more than 3 pips which is US$30 per round turn transaction.

But, in time of volatility, the spread may widen to 3 or 5 pips making the transaction rather expensive. Moreover, Forex brokers are like bucket shop where they trade against the client's order. With the advance in computer software, its easy for the brokers to take advantage of client's order without them knowing it.

Forex Brokers are not well regulated, if they collapsed, say bye bye to your money. Most firm offering Forex courses are also introducing brokers for recommending their students to the Forex Broker, earning a comm for every transaction done. Rather good recurring income.

Futures - It's the cheapest in term of transaction cost and Interactive Brokers offer the most competitive rates for retail customers.

Options - About the same comm as Futures but some strike price may not be liquid with rather wide spread from the market makers. This instrument is meant more for the professional traders.

In my next post, I shall discuss more on the cost of trading Futures compared to the other instruments.

13 comments:

coconut said...

just to share with your readers, my CFDs for SGX shares DMA comms is currently at 0.12%. with a monthly trade value of more than 10 million. i will be asking for less in the future.

for retail (actually i'm also a retail trader) trader, should be between 0.15% to 0.25%.

coconut said...

ya and thanks to fat who encourage me to ask for lower comms. with the competition the comms for shares or share CFDs will be even lower in the future.

Singapore Man Of Leisure said...

Hello FAT and Coconut,

I've been following this blog for several weeks now.

I really appreciate the insights to the world of full time trading. Very interesting!

coconut said...

3. ETFs, CFDs and Warrants, ofcos i like to defend what i refer to as DMA CFDs for stocks, it is the only intruments that you can easily go short on most of the stocks traded in SGX for retail trader, and as a market "participant" and not the broker as your counter party.

for ETF and Warrants, yes we are at the mercy of the issuing party. and most important we can't go short. i did use STI warrant (option) to hedge once only to discover i paid a very high premium. i rather be "short" than long warrant much like an option.

Fat88Trader said...

Man of Leisure! Wow

I wonder what will you do when you meet a Lady of Leisure. Just Joking.

Very interesting blog that you have, so relax and different from the rat race that we have here.

Fat88Trader said...
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Fat88Trader said...

OK, reason for using CFDs? To short a particular shares? Are you able to short any counter? Do you need to pay interest for shorting?

0.12% comm, very competitive, any other fees like Exchange clearing fees and GST?

coconut said...

what? you mean you have not investigate? (haha)

ok, yes to short individual counter, using margin trading.

depends on brokers, you might need to pay other charges like GST (for one of my account) but no clearing fees (as far as i know).

one important notes is that since it is trading margin on cash market, you have to incurr interest charges on long position and receive interest on short position. (but due to current low interest rate, the interest element should be between 1.5%pa to 2.5%pa and you would not receive any interest on short position.)

ofcos the most important reason to use CFDs is to make money trading. hope you enjoy yourself so far.

coconut said...

one thing i forget to mention is that although your order went through the exchange indirectly, someone down the line will have to pay for all the exchange fees, so whatever the broker charges you in the comms, it should be inclusive in them.

so check all the charges carefully.

coconut said...

another thing i forgot to mention (probably a thousand more) is that CFDs provider can gives very competitive rates for stocks is that they can skip paying their inhouse broker representatives fees unlike trading in the cash market.

Alvin said...
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Alvin said...

good recap after the interview with you :)

Alvin

Eileen said...

Thank you for the informative overview!

Eileen