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Explanations for Spread Cost Calculator
The OANDA Spread Cost Calculator uses some simple math, using the following factors
:
| Factor | Our assumption (for running examp
le) |
|---|
| Deals per day | 5 |
| Trades per deal | 2 (a deal consists of in and out trades) |
| Trading days per year | 250 |
| Leverage | 2 (this is a conservative estimate) |
| Account equity | $1 million |
Step 1: Multiplying these five factors gives the annual trading
volume:
5 x 2 x 250 x 2 x $1 million = $5 billion
Step 2: Calculate the absolute spread cost (the to
tal spread paid to the broker over the course of a year, expressed in account curre
ncy):
Annual trading volume x spread
2 |
|
(Note: if the quote currency of the pairs traded is diffe
rent from the currency of the account,
then spread costs would have to be converted from the quote currency to the account
currency.)
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Example: with an annual trading volume of $5 billion and a spread of 3 pips,
the absolute spread cost is $5 billion x .0003 / 2 or $750,000. |
Step 3: Calculate the relative spread cost (the to
tal amount of spread paid over the course of a
year as a percent of account equity):
Absolute spread cost
Account e
quity |
|
Using the same example as above, the relative spread cost with a 3-pip spread is $7
50,000/$1 million, or 75% of account equity.
With a 2-pip spread the relative spread cost would be $5 billion x .0002 / 2 / $1 m
illion, or 50% of account equity.
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Step 4:Calculate the potential expected profitability when switching to a br
oker who offers a lower spread
(in this example, from 3 pips to 2):
| Return with current spread | + | relative spread
cost (current spread) |
| - | relative spread cost (new spread) |
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Assuming a current annual return of 20%, and a move from a broker offering a 3-pip
spread to one offering a 2-pip spread,
on average, your return would increase from 20% of account equity to 45%: (20% + 75
% - 50% = 45%), a 125% increase.
That is, by reducing the spread by one third, profitability would more
than double
Note: Compounding is not taken into account in these calculations.
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