B/a spread, no commission and viability of small accounts

[Acuity]

First, I would like to thank BabyPips.com for making an awesome site. Second, I would like to thank the community for making an awesome forum. I have been reading the “School,” section as well of the forums, and have come across a couple of questions.

To my understanding, there are no commission fees with Forex trading, just the bid / ask spread for the brokerage to make their money. But to my understanding, the bid is what someone is willing to buy at and the ask is what the seller is willing to sell at. So if the Euro is trading against the USD at 1.42218, and I purchase it at that ask price, does this mean that the seller sells at the ask price, but only gets the bid price and the broker gets the spread? What about limit sales? Does the broker get nothing in that instance?

Also, at first I thought Forex was for rich people only; however, then I discovered leverage and wow was I wrong. I was successful at trading stocks in college despite commissions killing me half of the time trading on a formula I discovered. Now, after 6 more months or so of reading and paper trading, I would like to take the dive in to Forex. However, instead of using leverage/margin right away, I want to just trading on maybe a $2,000 account (I guess these are called micro lots). I realize that returns would be low, but I would be able to see movement and not experience deer in headlights syndrome so much while still getting my feet wet. Since there are no commissions, I shouldn’t get burned, so does this sound like a viable option and perhaps what someone might advise?

I really like the idea of Forex and, unlike stocks, even with a small portfolio I should be able to move in and out of positions quickly. Ever since getting out of college I’ve been bored after work since the markets were closed (for stocks at least). I’m so glad I found something else I can trade.

[Clint]

Regarding commissions and spreads, there are two broad categories of forex brokers: commission brokers (like MB Trading), and non-commission brokers (like FXCM).

A commission broker offers you the same Bid and Ask prices offered to him by the banks. Therefore, this broker makes no money on the spread; instead, he tacks a commission onto every trade.

A non-commission broker marks up the bank spread, and makes his profit on the mark-up.

Generally, you will pay a spread, no matter who your broker is. Very rarely you might get a zero spread, or even a negative spread, because spreads fluctuate — but, don’t count on this happening often.

As for the difference in transaction costs (to you, the retail forex customer) between a commission broker and a non-commission broker, the last time I did a comparison (about 3 years ago), between MB Trading and FXCM, MB Trading’s spread + commission was about 25% less expensive (averaged over about 50 trades) than FXCM’s higher spread (and no commission). Things might have changed over the past 3 years. You’ll have to do some due diligence.

The two broad categories of brokers described above are further divided into sub-categories. As part of your forex education, you will become acquainted with Market-Makers, No-Dealing-Desk (NDD) brokers, Straight-Through-Processing (STP) brokers, and Electronic Communications Network (ECN) brokers. So, when you’re ready for that, fasten your seat-belt, and get ready for some serious study.

No matter what kind of order you place, you will always be buying at the Ask price, or selling at the Bid price. If your broker is a market-maker, or an NDD broker, you will be buying (or selling) at the Ask price (or Bid price) [B]set by the broker[/B]. If your broker is an STP or ECN broker, you will be buying (or selling) at the Ask price (or Bid price) [B]set by the bank[/B] through which your broker is transacting your order. Memorize this, like a mantra: [B]Buy the Ask, Sell the Bid.[/B]

Regarding leverage, you can start out trading without leverage. But, I doubt that you will be content with that for very long.

Here is how you would start out. You said you intend to start with $2,000. If you open a Micro Account, you can trade lots as small as $1,000 (one micro lot). Obviously, if you buy $1,000 worth of currency with your $2,000 account, you are not leveraged.

Your broker will state a leverage figure as part of the product description of your account — but, it’s meaningless, in your case. Here’s why. The broker’s stated leverage, say 100:1, is a limit which you may not exceed; it isn’t leverage you are required to use. Think of it like the credit-limit on your credit card. If you charge $1,000 every month, and pay it off when the bill is due, your credit limit of $50,000 (or whatever) doesn’t mean anything.

You’ll get different opinions from different traders on when you should open a Micro Account. Some will tell you that demo accounts are a waste of time, and you should go live as soon as possible. I disagree. I think that while you are studying the BabyPips School lessons, reading as much as you can here on the Forum, and getting your questions answered here, you should be practicing on a demo account. Demo accounts are free, and you can have more than one.

You want to accomplish two things on a demo account, before you start trading live. You want to master the mechanics of trading (opening and closing positions, adjusting stop-losses, etc.), and you want to become proficient with at least one trading strategy. “Proficient” means consistently profitable. When you have accomplished those two things, then you’re ready to venture into live trading.

Live trading means getting involved with a broker. And that means that you have done your due diligence: you have studied the types, and sizes, and reputations of the major brokers out there, and you have made an informed decision.

Your past experience trading stocks will help you to evaluate brokers, and it will help you avoid some of the mistakes made by complete newbies who don’t have your prior trading experience.

Good luck with your next step. And stay in touch.

Clint