For most traders, trading costs is purely about the cost of brokerage. They tend to evaluate brokers purely based on the brokerage rate charged on equity and F&O. But you would be surprised to know that brokerage is only one of the costs that you incur when you trade. There are explicit costs, implicit costs and there are ancillary costs. It is only when you add up all these costs that you actually get a clear idea of how much costs you are incurring.
Look at the graphic below:
As the pictorial above indicates, brokerage that is levied on your transaction is only one of the costs that you incur. To get a clear picture of your trading costs, you need to factor in these 9 costs listed above. Let us look at each of these items in detail.
Explicit costs of trading in equity markets
These are the costs that are part of your contract note. Your contract note will clearly mention the price at which the stock was purchased, the number of shares purchased and the total value of purchase. In addition, the brokerage charges are also mentioned.
It is the charge you pay the broker for executing the transaction and for additional services like research, advisory support etc. Brokerage charges can be either fixed or variable depending on your agreement with the broker. In this case, there is one thing you need to remember. Most brokers charge brokerage for penny stocks at a base minimum rate which could effectively be much higher than the rate of brokerage promised to you. That is an additional cost you will have to factor in.
These statutory costs are again explicitly mentioned in your contract note. These costs don’t go to your broker but the broker just collects it from you and deposits it with the government. This includes GST, Securities Transaction Tax, state level stamp duty etc. In most cases, these statutory costs add up to more than the brokerage costs, especially when the brokerage charges are very low.
As a percentage of your total trading costs these are extremely small. These include exchange level charges, SEBI turnover fee etc. These are levied by the exchange on the broker and the broker in turn levies it on the customer. However, these charges are extremely nominal in the overall scheme of things.
Implicit costs of trading
Implicit costs are those that are not mentioned in your contract note. Such implicit costs are also quite hard to measure as their impact can vary based on circumstances.
A stock is liquid if you can buy or sell sufficient quantity of a stock at a particular price. In most of the large cap index stocks, liquidity is hardly the issue. But liquidity can become a major issue in a lot of mid cap and small cap stocks. Let us take an example. If you want to buy 10,000 shares of a company and can get it within a tick of 5-10 paisa, then that is fine. But if the volume is thin and an order of 10,000 shares will be available only Rs2 off the price then liquidity is an issue. This cost is a little difficult to quantify.
Spread costs are in some ways a variant of liquidity costs. These spread costs can arise in two different ways. For example, in some mid-cap stocks or during times of market volatility, the spread may become much wider. In a volatile market, traders try to get higher prices to sell and lower prices to buy and that increases the spread. In case of lower priced stocks, the spread actually gets magnified as a percentage of the stock price and that also imposes spread costs on the trader.
This is a slightly more convoluted concept and it occurs when your buy or sell order has the potential to move the price up or down. It imposes a cost on you as it increases your cost of buying or reduces your cost of selling. Impact costs are more visible in less liquid stocks and need to be managed either through hidden orders or by phasing out the orders.
Ancillary costs of trading in equities
These ancillary costs are not directly related to your transactions in the stock market, unlike explicit and implicit costs. But these costs are part of your trading ecosystem, which eventually get debited to you and impact your ROI.
Even if you are predominantly an intraday trader you will still need to have a demat account. Your DP will charge you an account opening charge, an annual maintenance charge (AMC) and each time your demat account gets debited, there is a cost that is passed on to you. You need to factor all these into your overall costs.
If your broker also has his own banking interface, then this is normally not an issue. Otherwise, there are charges like IMPS charges for transferring money into your trading account or payment gateway charges, which are debited to your ledger account.
This is a charge that your broker will debit to your account if you delay paying margins on time or if your pay-in gets delayed for various reasons. You also need to factor in these costs into your calculations.
The next time you trade, remember that it has much larger cost implications beyond just your brokerage!