Transaction Costs
The returns that have been reported on the Home page and the Description page include the following transaction costs:
When buying, the average HI-LO price of the day is adjusted
upward by 0.5%.
When selling, the average HI-LO price of the day is adjusted
downward by 0.5%.
The 0.5% cost was determined by calculating the average spread of stocks held in the model portfolio on randomly selected Thursdays and Fridays during January 2011 thru November 2011.
Dividends and distributions are not included unless they are substantial, but my data show that dividends and distributions would add approximately 0.5% to the annual returns of the model portfolio.
If you are a stock trader, you should be aware of your transaction costs. If your transaction costs are 0.5%, then your returns will equal my reported returns.
Some folks believe that the commission you're going to pay is the transaction cost. That is partially true, but there are far more important transaction costs to factor into the equation.
There is ONE minor factor and there are TWO major factors used to determine your transaction cost:
The MINOR factor is the discount broker’s commission.
The first MAJOR factor is the size of the transaction.
The second MAJOR factor is your variance from the average HI-LO
price of the day.
In plain English, the cost of the transaction is the difference between the actual price and the average price.
In mathematical terms, the transaction cost is a function of the true price per share and the average price per share.
Formula for the transaction cost in percentage terms when buying:
Transaction cost = (True cost per share - Avg price per share) /
Avg price per share
Multiply the answer by 100 to
convert to it to a percentage.
IF the "True cost per share" is equal to the "Average price per share", then your transaction cost will be zero (zero divided by a non-zero value is equal to zero).
IF the "True cost per share" is less than the "Average price per share", then your transaction cost will be negative. Negative transaction costs are highly desirable.
IF the "True cost per share" is greater than the "Average price per share", then your transaction cost will be positive. Positive transaction costs are NOT desirable.
Formula for the transaction cost in percentage terms when selling:
Transaction cost = (Avg price per share - True price per share) /
Avg price per share
Multiply the answer by 100 to convert to it to a percentage
Unfortunately, buying or selling at the average HI-LO price of the day is not as easy as it sounds. Many of the stocks that are recommended are volatile, meaning their prices may vary considerably during any day.
If you are buying, and if you are able to buy at the low side of the daily price range then your transaction costs will probably be negative. If you buy close to the average daily price then your transaction cost will be low, possibly even negative.
If you buy at the high side of the daily price range then your transaction costs are likely to be high. The converse is true if you are selling.
Transaction costs vary quite a bit because they are dependent on the skill of the trader and the size of the transaction. There are a few simple rules to follow in order to limit transaction costs. Use a discount broker and NEVER place a market order. I usually check prices at around noon and if I’m buying I will submit an offer a little lower than the average HI-LO price of the day; if I’m selling then I will submit an offer a little higher. I then wait until 3:30 to determine if the offer executed. If it did not execute then I will buy or sell using a limit order at the market price. This usually works reasonably well meaning that most of the time my transaction costs are at or below zero, but frequently they are not. There are innumerable variations to this theme but their development is probably best left to the individual trader. You are either going to get very good at this game or you are probably going to quit.
My on-line discount broker is currently Vanguard, but before I switched to Vanguard, I had an account with Ameritrade for more than ten years. The standard commission for an on-line Ameritrade market or limit order is $9.99. Ameritrade and perhaps other on-line brokers are willing to negotiate if you are a high volume trader. If you buy and sell thirty or more stocks every quarter then you are a high volume trader. It will take about two months to establish a trading pattern. After that, you should easily be able to negotiate $5.00 a trade with Ameritrade.
There are many lesser known deep discount brokers. I have not tried them myself, nor do I know anyone well who has, but you can find them on the web. Before you commit serious money to any broker, check with the SEC and the Securities Investor Protection Corp (SIPC) to determine if the broker is covered by adequate insurance.
One of my subscribers had a problem with Scottrade: I do not recommend stocks under one dollar, but on rare occasions the price of a recommended stock falls below one dollar. Scottrade charges a premium to process these stocks.