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Retail Brokers May Take Away 10% of Account Equity Every Month

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The two most overlooked parameters when choosing a fx broker are rollover and foreign exchange costs. Many are not even aware of them, even if such costs may be equal 2-3 or even 10% of account equity per month.

Usually a potential client looks at spreads, user interface and technology to choose an account. There are other things to consider and those are so important that can easily be a deal-breaker.

Rollover cost is one of such. And such rollover cost may not be obvious until one starts to trade. You receive interest for long currency positions in your account and pay interest for short currency positions. Say, if interest rate for Australian dollar is 5%, you should collect this interest on you long positions and pay interest at the same rate for short positions. In practice, those rates are set by the broker and, in a typical case, you are likely to receive 3% and pay 7% rather than 5% both ways. It is systematic to abuse interest rate setting and a real life example is that clients pay as high as 30% rollover cost. In other words – if you have a short position over a 12 month period and the currency duly declines 30%, you make nothing, just because your profit is taken away as rollover cost, if taxed at rate of 30% p.a.

Another issue is foreign exchange cost (for any type brokerage account, not only FX). If there is a clause in the account agreement that all P/L is converted to account base currency at the end of the day, all you P/L balance in foreign currency will be converted to base currency at close of business day at bid price and bought back at ask price at the beginning of the next business day. Such bid-ask spread may be as wide as 0.5% and your P/L will be continuously taxed at this rate daily. Say, if the account base currency is EUR, but half of the account equity consist of profits denominated in GBP – half of the account equity will be taxed through currency conversions – even if no trades are placed in the account, account equity can decline by as much as 8-9% per month as a result of foreign exchange cost as imposed by brokers.

Those are very unfavorable odds to trade against – as much as 10-11% of account equity per month may accrue as imposed transaction costs. Thread carefully and better avoid retail brokers.

Written by A.S.

July 16, 2014 at 9:50 am