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Nickel & Dime

A word of advice to beginning traders: if you skimp on your bankroll, trading commissions will kill you.

This is true for even the super “discount” brokers. Suppose you open an account with an online broker for $1,000, and the broker charges $10 per trade. In this case, it is highly unlikely you will be able to profit from frequent trading because the $10 per transaction will eat your bankroll alive, even if you select winning stocks.

Here is an example. Suppose you invest ¼ of your $1,000 on a trade for $250. Now suppose that trade returns a whopping 10% gain. Did you make 10% on your $250 investment? No, because buying the stock cost you $10, and if you sell the stock for profit that will cost another $10, so your net gain is only $5. By any standard, a 10% move on a single trade is substantial, but because of commissions you would only realize 2%. Certainly, if all your trades returned 2%, this would not be a problem. But realistically, you will have enough losers to overwhelm these small profits.

Since some of your trades will lose money, scratching for 2% gains won’t be enough to grow your account overall, and in fact you will probably lose money. The only chance you would have is to build a small portfolio and hope that it grows continuously over very long periods of time to swamp the commissions. Frequent trading, however, will be out of the question.

With a much larger account, say $10,000 or more, the commissions become more negligible. For instance, trading 1/4 of your stake would have been for $2,500, returning $230, which is much closer to the stock’s gain of 10%. With a $100,000 bankroll, the commissions are reduced even further, to near insignificance.

Trading is like any other business and requires sufficient capital. While the idea of running up a shoestring to some miracle profit is romantic, it is unrealistic if not impossible making frequent trades. This is due to the broker’s commissions, something that is rarely discussed in other literature about trading.