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Trading paradox – trading is bad for us, but we still do it Print

Bid/ask (spread) costs

Spread costs are the difference between the bid and ask prices for publicly traded securities. A trader who completes a cycle (buy then sell) in effect is charged with the spread between the two. Thus, if the market for the shares of BCE Inc. is $ 29 5 / 8 bid and $ 29 7 / 8 asked a purchase and immediate resale would cost you 2 / 8 or 84 basis points (0.84%), and a one-way purchase is likely to cost you half, or 42 basis points. This cost sometimes exceeds the commission explicitly disclosed on your trade confirmation slip. Although not shown on the slip it is very real cost.

The average spread on Canadian equities is currently less than 4 basis points on normal trading days, and can be much higher in volatile situations; see Mathisson Credit Suisse 2011 doc.2218, slides 13-15. When you use a discount broker, the bid-ask spreads can be easily seen when placing an order online, at least for shares. The cumulative cost of bid-ask spreads increases the more one trades; see

On the particular case of ETF spreads, see Nigam 2010 ETF spreads PDF doc.2221. It has been suggested that limit orders should be used to reduce ETF spread trading costs; see Canadian Couch potato 2012 ETF Pricing Spreads PDF doc.2215; and Allen 2003 Trading Strategies For Longer Term Investors- limit orders PDF doc.2229. See also TradeTrek

Impact costs

Market impact costs are the costs incurred when the price of a security changes as a result of the effort to purchase or sell. The more widely traded a security, the smaller are the spread and market impact costs. Typically, market impact costs are small for retail investors trading in actively traded equity securities, but can be much more  significant for equity securities which trade infrequently, for example small-cap equities,  and for many bonds and preferred shares; on bonds, see  Pett NP 2012 Lack of liquidity bonds and shares PDF doc.2222.

When you use a discount broker, the impact cost cannot be easily seen when placing an order; however, the discount broker will sometimes notify you that your order is greater than the current number of shares being offered for purchase or sale, in effect warning you that the size of your order may impact the price you can expect to pay.

For more on this subject for mutual funds, see How much do actively-managed mutual funds cost investors ?  


Transactions also generate tax costs. The more an investor trades in his regular, taxable accounts, the greater the tax bill. Why?

An investor who never disposed of his investments would never realize capital gains and would never have to include gains in his tax return. In the real world almost all investors sell or turn over all or part of their portfolio each year, leading to potentially important tax costs. When an investor disposes of investments that have increased in value capital gains taxes are triggered. These gains and the resulting taxes would have to be incurred in any event eventually but because of accelerated turnover the taxes become payable at a much earlier time. Low portfolio turnover is more tax efficient then portfolios that turn over at a high rate. For more, see for the particular case of mutual funds How much do actively-managed mutual funds cost investors ?   

Trading where securities are sold at a loss is a particular subject. On the one hand intentionally selling to crystallize a loss for tax purposes can be beneficial; it is called tax-loss harvesting, and is an example of the advantage an individual investor has by directly investing, rather than through a fund (funds typically do not practice tax-loss harvesting even though it could be beneficial to the fund’s investors). But tax-loss harvesting is rarely the objective of over-trading investors, and if an over-trading investor does trigger such a loss but repurchases the same securities within a short period (30 days in Canada and the US) the tax-loss harvesting benefit is lost in any event. Why? Because tax rules deny the immediate tax deduction normally available on the original sale (in Canada, this is called a superficial loss). N.B.: the loss and the resulting tax deduction is eventually recoverable when the repurchased securities are resold, but a deferral of the ability to claim a loss has a financial cost to the investor.

Last Updated ( Thursday, 10 January 2013 )
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