Commissions In Trading (Definitions And Examples)
Last Updated on April 18, 2023
Trading is hard, and you want to keep as much of the profits as possible. But unfortunately, you need to pay commissions whether you win or lose on a trade. In this short article, we look at how commissions eat into your profits (or add to your losses).
(Some brokers offer no commissions but you can be sure you pay other fees or “invisible” costs. There is no free lunch in trading!)
First, let’s start by defining commissions in trading:
What are commissions in trading?
A commission refers to the fee that a broker charges for carrying out transactions in a trading account. Whenever you initiate a trade order to purchase or sell securities such as stocks, bonds, exchange-traded funds, futures, options, or any other securities in your brokerage account, the commission is the charge levied by the brokerage firm for facilitating the transaction.
The commission might be fixed per transaction, or it might be variable. For example, some brokers might offer trading for 4.9 USD per trade, while another broker might offer 1 cent per share traded and a minimum of one dollar.
It all varies, and you pick your broker based on your trading style.
Can you get paid a commission?
Yes, as a matter of fact, you can. That is called rebate trading which we covered earlier.
Why do commissions matter?
As someone new to trading, it’s easy to think that if you’ve just found a good strategy, then it’s just a matter of buying and selling and making money.
However, brokerage costs and commissions are extremely important to understand properly if you want to succeed in trading, yet it is rarely discussed. Sometimes it’s the difference between success and failure. Before you start trading, it is important that you have estimated how much you’ll pay in commissions in order to determine your net gains (or losses).
The truth about trading is that strategies are, first of all, very hard to find. If you find a strategy that works, it might not have a large profit margin. This means that if you find an “edge/strategy” on the stock market that you want to start making money on, the profits are rarely much greater than the losses. In other words, to maximize your profits you should keep your costs low. It’s really no different than running any business.
We have traded full-time for over 20 years and we have first-hand experience with how much commissions matter.
Below we have made a diagram that shows the different net results depending on the commission rate. In this chart, the commission for both buying and selling has been deducted for each trade.
How are commissions in trading calculated? Commission example
For example, if you have traded shares worth 10,000 and the strategy has a positive expectancy of 2% gross (before commissions), then the profit is (in the long run) expected to be 200. If commissions are 0.25% of the amount traded each way (both buy and sell), the profit is reduced to 150 (200 -10000*0.25% – 10200*0.25%).
This may not trouble you for one trade, but trading is a numbers game. Commissions eat into your profits.
Another way to calculate commissions is to look at all trades you have completed in the past and divide the gross amount bought and sold.
For example, if you have bought shares for 20,000 and paid a commission of 40, the commission will be 0.20% (40/20,000).
Some brokers have different commission structures to allocate for many types of traders. Some brokers may also have a minimum fee for each transaction, which should also be taken into account.
Commissions in trading – conclusion
Do yourself a favor and spend some time finding the best broker for your needs. It can often be the difference between success or failure!