Understanding costs

When you make trades, there are several potential costs you need to be aware of. Because a demo trading account simulates a real trading environment, even though you're not trading with real money, many of these costs are simulated too, to help you understand exactly what fees and expenses you would incur in a real-world environment.

In this lesson, we look at the main types of trading fees, costs and other critical monetary considerations, and how these might differ between various products.

What are trading fees?

Trading fees are the primary way in which brokers make their money. They apply when you buy or sell an asset and are paid to the broker as a commission for helping to facilitate the trade through their platform. Trading fees vary substantially from product to product, so they will be different if you are trading forex, options, stocks, and so on. They also vary between brokers.

Fee models will also vary. For example, some brokerages offer a discount on trading fees for people trading particularly large volumes. Some charge a flat trade fee to initiate any trade, regardless of the volumes you're trading, while others charge a commission per unit traded. Still others use a combination of both (a base fee, plus a fee per unit traded).

It's important to understand trading fees because they affect the amount of money you end up with.

Types of trading fees and costs

Let’s take a look at some of the most common types of fees and costs you’re likely to encounter as you explore your demo trading account:

Spread

In trading, a spread is the difference between the buy (offer) and sell (bid) prices quoted for any given asset. Many brokers quote their prices in the form of a spread. This simply means that the price you will pay to buy an asset will always be slightly higher than the underlying market, while the price to sell will always be slightly below it.

You can calculate the spread by deducting the bid price from the offer price. When you're trading products with a spread, you're hoping that the market price will move beyond the price of the spread so that your trade can be closed in profit. If the price doesn't move beyond the cost of the spread, you risk closing the trade at a loss, even if the market moves in the direction you had predicted.

When it comes to calculating your total spread cost, you can do this by multiplying the monetary value of your position per point by the spread. It's important to bear in mind that CFD position sizes are based on contracts or lots, which means the calculation involves an extra step.

For example, if you purchase 1 contract from a specific market index fund, where 1 contract is valued at $10 per point, and the spread between the bid and ask price is 1 point, your total spread cost of this trade would be:

1 contract x $10 per point (the value of the contract) x 1 point spread; total cost = $10

Overnight funding

If you hold a short-term trade and you decide to keep it open overnight, you'll be charged a daily interest fee in the case of CFD positions. This is because these products are leveraged, which means you're effectively being lent the money required to open your position. To keep this position open after 2pm (UAE time), your position needs to be funded overnight, and this means an interest adjustment will be made to your account to reflect that cost.

It's important to understand that overnight funding charges will be shown as separate charges on your account and not reflected in your running profit/loss (usually delivered via an email statement). You need to take these charges into account when calculating your actual profit. It's also critical to understand that overnight funding is calculated differently for indices, stocks and ETFs, forex, commodities and other markets.

Gross exposure

Something that many beginner and intermediate traders struggle to understand is the potential impact of their gross exposure on their profit or loss.

Financial exposure is simply the amount of capital that you stand to lose when you make a trade or investment, also known as risk. When you invest in an asset, your exposure is limited to the amount that you spend on opening a position. For example, if you buy 100 stocks in ACME Company and they lose all of their value, the maximum amount you stand to lose is what you paid for them.

However, when you trade with leverage, your exposure increases because your capital is amplified beyond the initial money you put down, known as your margin (deposit). In these cases, your profit and losses can also be magnified. For example, if your margin was 25%, your risk exposure would be 75% beyond the amount you deposited. Therefore, if you opened the trade and paid a margin of $250, your exposure would be $1000. This is your net exposure on a trade.

Your gross exposure is the sum of all your net exposures -- adding the values of the exposure on all your individual trade positions together.

In the next lesson, we'll look at some of the important metrics to consider when evaluating your trading performance, as well as some different ways to use your demo account to experiment with different products.