IMPACT OF TRANSACTION COSTS

Transaction costs are the greatest deterrent to day-trading profits. The failure to execute near the intended price, plus the commission costs. can remove a large part of potential profitability and even turn expected profits into losses. An aspiring day trader has two ways of improving performance: by paying lower commissions and by careful selection of opportunities. The average dollar volatility for the years 1990 through 1996 is shown next to the percentage represented by a $100 transaction cost. In general, $ 100 is a modest value for the combination of commissions and slippage, and traders would be very pleased to extract an average profit of one-half the daily volatility. A practical approach would therefore use twice the percentage effect of a $100 cost shown here.
Realistically, a day trader would choose the index markets, more volatile currencies, and long-term interest rates as their best opportunity for profits. Com represents the least desirable market because very low volatility leaves more risk than opportunity. Although a $ 100 transaction cost may seem high for this market, a $20 commission and slippage equal to a minimum move of 1/4c, or $12.50, totaling $45, would be the smallest possible costs. An occasional fast move in the market, based on unexpected economic news, or large orders entering at one time, must result in a larger number, raising the average.
To keep dollar volatility of a futures contract to a level acceptable by most traders, exchanges have been forced to resize contracts, specifically stock index markets, as overall share values have climbed. During 1997, the S&P was reduced from $500 per basis point to $250, and the FTSE-100 from £25 to £10. In 1998, the French CAC40 contract was cut to 25% of its previous size. This increases the relative size of transaction costs.