What are transaction costs?

Transaction costs refer to the expenses that investors or traders incur when buying or selling securities. These costs are essential to understand because they can significantly impact the overall profitability of trading strategies.

When purchasing or selling securities, various types of costs are involved—such as broker commissions, bid-ask spreads, and other fees associated with executing trades. For instance, if a trader buys a stock, they may pay a commission to the broker facilitating the trade, and they will often buy at a higher price than the actual market price due to the bid-ask spread. All these elements contribute to the total cost of executing a transaction and ultimately affect any returns realized from trading activities.

Understanding transaction costs is crucial for making informed investment decisions and evaluating the true performance of trading strategies over time. This awareness helps traders develop strategies that minimize these costs, thereby maximizing their potential profits.