Learn The Stock Market Lesson - Commissions and Slippage
Have you ever wondered why many traders lose and get beaten by the market? Such factors include not only emotional and thoughtless trading, but commissions and slippage as well. Many amateurs ignore or refuse to believe this, but the fact is that the trading industry and the market are designed so that most traders lose money. Commissions and slippage play a significant role in accomplishing that.
Commissions are what you pay to enter and exit a trade. It is a fee charged by brokers for their service in facilitating a transaction, such as the buying or selling of securities. Commissions vary from brokerage to brokerage. However, this does not mean that you should look for the lowest commission available, although that is a factor that many traders consider before a transaction. This is because the brokerage that charges a low commission might not necessarily be the best one for you. For example, discount brokerages offer no advice and are probably not recommended for new investors. Depending on your preference, you might feel that a full-service brokerage suits your taste better because of their personalized service, but of course, commissions are much higher also. I will do a comparison of online brokers in a later post.
Slippage is the difference between the price at which you place your order and the price at which it actually executes at. It is like paying 70 cents for a pen even though the store posted the price to be 68 cents. Slippage often occurs when market orders are used but if you place a limit order, it is filled at your price or not at all.
There are 3 kinds of slippage:
1) Common – This slippage is due to a spread between buying and selling prices, or the spread between the bid and the ask.
2) Volatility-based – Slippage often occurs during periods of higher volatility, rising up with market volatility.
3) Criminal – This type is caused by criminal activities of floor traders, who have many ways of stealing money from customers.
To reduce slippage, avoid thin and fast-moving markets because when there is a big rally or drop, you can get hit with a 20-30 point slippage, and sometimes even more. You can also use limit orders, buying and selling only at a specified price.
Remember to beware of your commissions and slippage. It is recommended that you keep a record, making note of what the floor traders and brokers are taking from us from each transaction.
