What are Trading Costs?

Alexis W.
Alexis W.

Trading costs refer to the cost of buying and selling stocks on a stock market. Trading costs may include actual costs, such as commissions and fees. These costs may also include the opportunity cost that a person incurs when buying a stock or bond.

Businessman with a briefcase
Businessman with a briefcase

When a person decides to buy a stock or bond on the stock market, he must place an order. This is most often done through a stock broker or brokerage firm, since individuals typically do not go to the stock exchange to buy stocks on the "floor" of the stock exchange. When this order is placed, certain costs are incurred.

Costs may include opportunity costs. These are the costs that exist because an individual cannot place an order immediately. For example, if a person wants to buy stock and decides he is interested when the stock is valued at $10 US Dollars (USD) but is not able to get the order in until the stock goes up to $10.01 USD, then the additional $0.01 USD per share that he must pay is part of his trading costs.

The more standard definition, however, refers to fees and commissions that a person must pay when he trades stocks. Buying and selling stocks on the stock market is not free, since individuals must do this through a brokerage firm. The brokerage firm charges for using its system and services to purchase stocks on the market, and these costs are referred to as trading costs.

Many full-service brokerage firms charge high trading fees. If, for example, a trader gets guidance from a broker and the broker provides education and advice in addition to purchasing stocks for the investor, the commission tends to be higher. In some cases, the commission or cost of executing a trade may be as high as more than $100 USD or the equivalent, depending on the country the broker and individual are working in.

With the advent of online brokerages and discount brokerage firms, trading costs have become lower in many cases. For example, discount online brokers allow individuals to trade stocks for a small fee on their own, often $10 USD or under in the United States. These brokerage firms do not offer the same level of advice and financial education that a full-service brokerage firm offers, but trading costs are much lower.

The cost of a trade must be deduced from profit to determine the actual rate of return. For example, if an investor makes $100 USD on a stock trade, he must subtract the trading costs he incurred to make the trade. If he is charged $10 USD to buy the stock and another $10 USD to sell the stock, his actual profit is $80 USD.

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