Every Trade Starts Negative

Every position opens at a loss, and one of the four charges keeps deepening it for as long as you hold. The spread, commission, slippage and financing are all taken for reasons that have nothing to do with whether the trade works, and their sum is the number lesson 4’s breakeven formula was actually asking for. On the trade priced below, the spread is $2.00 of a $9.29 bill, and the win rate you need just to break even moves from 50.8 to 53.9 per cent.

Prerequisites: Lesson 4, for s and the breakeven it produces, and lesson 3, for why crossing is a choice with a price attached.

One trade, priced properly

Buy 200 shares of a $50 stock — a $10,000 position — with a stop $0.60 away. The money at risk is 200 × $0.60 = $120, and that $120 is the denominator for everything below.

The stock is quoted a penny wide. Your broker charges half a cent a share each way with a $1 minimum. On the way in your 200 shares were bigger than what was resting at the ask, so the fill averaged a cent past the quote; the exit filled at the quote. You bought on 2:1 margin, so $5,000 of it is borrowed at 8 per cent a year, and you held it three nights.

Charge	Arithmetic	Cost
Spread	$0.01 × 200, once for the round trip	$2.00
Commission	$1.00 each way	$2.00
Slippage	$0.01 average × 200, on the entry only	$2.00
Financing	$5,000 × 8% × 3 ÷ 365	$3.29
Total		$9.29

Now run it through the formula twice. On the spread alone, s = $2.00 ÷ $120, or 1.7 per cent, and the breakeven win rate is 50.8 per cent — the reassuring number, and the one lesson 4 would have given you. On all four, s = $9.29 ÷ $120, or 7.7 per cent, and the breakeven win rate is 53.9 per cent.

Three points of win rate is three more wins in every hundred trades, asked of a setup that has not changed. And only one of the four charges is visible on a chart: in this bill the spread is $2.00 of $9.29, under a quarter of what the trade cost, and the three you cannot see are the rest of it.

What this does not settle

That these are your numbers. Commission schedules, borrow rates and funding payments differ by broker, instrument and country, and the slippage line is the one that varies most — it is a measurement of your own fills against your own book, which is what lesson 11 is for. Take the four for yourself and the arithmetic here is a template rather than a claim.

Nor does it establish that everything scales with your size. Spread and financing do: double the position and both double, the risk doubles too, and s is unchanged. The other two do not. Slippage grows faster than size, because a bigger order reaches further into the book, and a commission floor works the other way — at 200 shares the minimum works out to a cent a share on the round trip, and at 100 shares the same minimum is two cents a share. The smallest accounts pay the most per share, which is the opposite of what a percentage fee would do.

And the breakeven still assumes one-to-one reward to risk, exactly as it did in lesson 4. Change the payoff and the threshold changes with it. The four charges are also not quite the whole list: tax and currency conversion sit outside them, and tax is lesson 78.

Most of all, none of this is an edge. Driving s to zero does not make a coin flip profitable; it only stops the coin flip from being a slow loss. Cost sets the bar. Clearing it is the rest of the course.

The trade starts at −$9.29. Everything you do afterwards is an attempt to get back to zero and then past it, and knowing the size of that hole is what tells you whether the attempt is reasonable.

Problems

1. Take one charge away. Rerun the trade at a zero-commission broker, changing nothing else. Give the new total, the new s and the new breakeven win rate, and say how many points of win rate the commission was worth. Then say whether that answer would change which broker you use.
2. Find where the columns cross. On the same position and the same 8 per cent, how many nights does it take before financing alone equals the other three charges put together? Give the number, and then say what that implies about holding a trade with a $0.60 stop for a month.
3. Take your own four. For your last ten trades, record all four charges and the currency at risk, and compute s for each. Your median is the bar your setup has been clearing, or not. Compare it to the spread-only figure you computed in lesson 4, and say which of the four charges is doing the most damage — because that is the one worth working on, and it may not be the one you have been working on.

Sources. Brad Barber and Terrance Odean, “Trading Is Hazardous to Your Wealth” (Journal of Finance 55, 2000), which separates what a household’s stock picks earned from what the household earned, and finds the gap in turnover multiplied by cost. Richard Roll, “A Simple Implicit Measure of the Effective Bid-Ask Spread” (Journal of Finance 39, 1984), the ancestor of every method for recovering real trading cost from prices rather than from a fee schedule. Charles Jones, “A Century of Stock Market Liquidity and Trading Costs” (Columbia working paper, 2002), on how far commissions and spreads have fallen — which is why the charges that have not fallen now dominate.

Three of the four charges you can read off a schedule before you trade. The fourth you have to measure, it is the one that grows with your size, and the next lesson is how to put a number on it.

Educational only. Trading involves substantial risk of loss. Not financial advice. Past performance does not guarantee future results.