Trading cost/Transaction cost

Key Takeaways

• Trading costs or transaction costs are all the costs that the trader/investor incurs when transacting on the market

• The returns for the trader or investor, are on the sum of money that remains after the transaction costs have been accounted for

• Examples of transaction costs are broker charges, stamp duties, etc.

• Trading cost consists of two parts: implicit and explicit

What is a Transaction Cost?

Trading costs or transaction costs are all the costs that the trader/investor incurs when transacting on the market, and which are deducted from the sum of money they spend when transacting. Examples of transaction costs are commission from the broker and spread.

Investors give importance to transaction costs because they affect the returns that the investors would get from an investment. Higher transaction costs decrease the investor’s returns. The returns for the trader or investor, are on the sum of money that remains after the transaction costs have been accounted for. 

The transaction cost is the payment that banks or brokers get for their job. Transaction cost is also used in reference to the amount that brokers get for their work in buying or selling of real estate. Costs incurred while moving goods from one place to another is also referred to as transaction cost.

Examples of Trading Cost

Trading costs comprise explicit costs and implicit costs. 

Explicit costs are the direct costs of trading, such as brokerage charges, taxes, stamp duties, and fees paid to the exchanges. The trader may be given a receipt for such costs. 

Implicit costs are indirect trading costs. The trader does not get a receipt but has to pay them, nevertheless. Implicit costs include the bid ask spread and the impact cost of a trade.

Types of Trading Cost

Below mentioned costs are the most common transaction costs in market:

Search and information Cost: This cost is related to finding relevant information and contacting agents with whose help, transaction will be executed.

Bargaining Cost: Bargaining costs are related to the costs incurred while coming down to an agreement between all the concerned parties.

Enforcement Cost:  Enforcement cost includes the cost incurred in making sure that all the parties keep their word. Lawyer’s fee is an example of an enforcement cost.