Forex Trading

Explanations for Spread Cost Calculator

The OANDA Spread Cost Calculator uses some simple math, using the following factors:

Factor Our assumption (for running example)
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 total spread paid to the broker over the course of a year, expressed in account currency):

 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.)
 
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 total amount of spread paid over the course of a year as a percent of account equity):

 Absolute spread cost 
Account equity
 
Using the same example as above, the relative spread cost with a 3-pip spread is $750,000/$1 million, or 75% of account equity. With a 2-pip spread the relative spread cost would be $5 billion x .0002 / 2 / $1 million, or 50% of account equity.

Step 4: Calculate the potential expected profitability when switching to a broker 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)

 
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.


Go back to the spread cost calculator.