I’ve had some email conversations with potential subscribers of the Power Dip. Invariably, commissions are a major topic of discussion. I’m going to flesh out some thoughts on commissions and system trading, in part because I think it will be helpful to have as a resource for anyone with a small account who is considering system trading.
Commission Structure-
There are two distinct commission structures that are available to most retail traders: Fixed Cost and Per Share.
Fixed Cost is what Scottrade uses as a major selling point for its brokerage services (7 buck trades).
Per Share pricing of .005 / share is why Interactive Brokers is well-known (very cheap, great brokerage).
And there are hybrid models, such as one structure that Tradestation offers, where per share prices are .01/share for the first 500 shares, and then .006 for any shares thereafter.
The Size of Your Account and the Way You Trade Should Determine Your Commission Structure-
Small accounts, 10K-30K should consider using a per share commission structure.
Let me give an example of how important this can be for small account traders.
The Power Dip system has made 116 trades since May (5 months), for an average of 23 trades a month. Remember that every closed trade is really two trades- the buy and the sell- and so actually the system has made 232 trades.
Fixed Cost Commissions
$7.00Commisions*232Trades=$1624.00
($1624/$10000)*100 = 16.24%
If a trader’s account started with 10K, he has now spent 16.24% of his capital on fixed cost commissions, in only 5 months.
Per Share Commissions
I’m using 10% of the actual number of shares as recorded on the Power Dip spreadsheet to approximate the position sizes a 10K account might use.
It is important to remember that the number of shares must be doubled.
$.005*(10095shares*2)=$100.95
($100.95/$10000) *100= 1%
If a trader’s account started with 10K, he has now spent 1% of his capital on per share commissions, in 5 months. This trader has just reduced his cost of doing business by 94% over the trader who used fixed cost commissions.
And the Drawdown Begins with the First Trade-
When system trading it is crucial to have a plan for the worst-case scenario, while expecting a much better outcome. Along this line of thinking, traders should be aware that a drawdown can start with the very first trade. If the account starts with 10K, and immediately trades into a 15% drawdown, fixed cost commission structure will rob the account of another 10-15%. It will not be easy to continue trading a system after a quick 25% haircut. And to make matters worse, as the account loses money, and positions get smaller, the commissions will stay the same!
While fixed cost structure is not so detrimental to a 30K account (5.4% cost of commissions, using the figures from the example above), it still grows a 15% drawdown into a 20% drawdown.
What If You Trade Mostly Cheap Stocks?
For these examples, I will be using 1 month’s worth of trade data from another system I’m trading. The system makes an average of 5 trades a day, mostly on stocks priced in the $1.00-$4.00 range (meaning it will buy/sell a lot more shares than if the shares were more expensive). It has traded 36,900*2 shares since August 31st and made 67*2 trades.
Fixed cost = $5*(67*2) = $670.00 note that I lowered the fixed cost to $5.00
Per share = $.005(36,900*2) = $369.00
The example above shows that for small accounts, a fixed cost structure will be superior to a per share structure IF it trades large positions of cheap stocks. Obviously my system is not trading large enough positions of cheap stocks to benefit yet from fixed cost commissions.
Summary
The most effective way to manage commissions may be to split capital into 2 accounts at different brokerages where the fixed cost account is used to trade cheap stocks and the per share account is used to trade more expensive issues.
Commissions are a cost of doing business. As such, they must be managed just as any other business cost would be. Traders with small accounts must be very careful to match their account size and trading style with the appropriate commission structure or they may not be in business for long.
Good post.
Tradestation charges $0.01/share with a minimum of $1 per trade. I believe IB works the same (minimum of $1 per trade). Your per share commission calculation doesn’t take this into consideration.
10,095 shares / 232 trades = avg position of 44 shares, which would be $2 round trip, rather than $0.44
And as you’ve stated before, Tradestation has a minimum shares/trade requirement in order to avoid the $100/month platform fee; which encourages low-priced stock picks for smaller accounts, which may lead to more slippage (though small odd lots lead to slippage as well).
Does all this mean you will be considering stock price as part of your subscription trades? I imagine you don’t want to go there.
Divide your shares by 116 instead of 232, or multiply your share by 2.
Doing so gives 87 shares per trade, which is getting closer to not being odd lot.
Ah, I missed that it was 116 positions (232 round trip trades).
Right you are.
I didn’t include the 1/share minimum because in the first example it would only raise the cost of from 100 to 200, or 1% to 2%. The point remains that that is much cheaper than fixed cost, and the calculations were meant to be hypothetical. You are right however about the 1.00 minimum.
We have been tracking slippage across 2 different systems and have been seeing positive slippage on average of .005, even though one strategy trades very cheap stocks and one account has a lot of odd lots.
The key is to trade contrarian to the herd.
Great post. I guess I’ll be doing an expense analysis this weekend.
I haven’t revisited my commission costs, since I switched from Schwab ($29 + %) to Scottrade ($7). Schwab started charging a quarterly inactivity fee and at the time I wasn’t actively trading (during the 2000-2002 bear market in long only accounts. Of course this was before the introduction of iETF’s). I called and begged and begged, since I had multiple accounts, and had been a customer since the beginning of time and had given them much in commission and margin interest. No dice. So I switched to the folks from St. Louis…