Wednesday, November 16, 2011

Currency Trading Should be More like Stock Trading

A constant irritant of mine is the high cost of converting between U.S. and Canadian dollars at my discount brokerage. Canadian Capitalist has a good way to reduce these currency-conversion costs, but it involves several steps. I wish that my discount brokerage would offer a more sensible option.

When I trade stocks or ETFs, I have to contend with commissions and spreads. Most people understand commissions, but spreads are less familiar. Consider the ETF XIU. As I write this, it is trading at a bid price of $17.51 and an ask price of $17.52. This means that the price per unit is different by one cent depending on whether I'm buying or selling. For $100,000 worth of XIU, this difference is $57. Each time I make a trade, I lose half of this spread, or about $28.50. Add in the trading commission of $10, and the cost to me is $38.50.

Things are very different when buying or selling U.S. dollars. If I don't do anything special to avoid high costs, the spread at my discount brokerage on large amounts is 1%. This means that if the Canadian and U.S. dollars were at par with each other, I'd have to pay C$100,500 to buy US$100,000 but would only get C$99,500 if I sold US$100,000. There is no explicit commission, but the spread costs me $500 on each conversion! Compare this to only $38.50 when trading the same dollar amount of XIU.

Something much more sensible for converting between Canadian and U.S. dollars would be a much lower spread and an explicit commission. With a $10 commission and a spread of say 0.05%, the cost of converting $100,000 would be only $35, which is much more reasonable. For $10,000, the cost would be $12.50. I may not have chosen exactly the right commission and spread amounts, but this model of an explicit commission plus a greatly reduced spread much more fairly reflects a brokerage's costs of performing currency conversions.

5 comments:

  1. The brokerage care not for sensibility. They care that the current system is highly profitable for them. And so long as it remains profitable, they would not change the system.

    So let's hope Vanguard and others will start to offer non-hedged version of US and international ETF's.

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  2. @P2sam: I agree with you that brokerages like highly profitable currency conversions. My hope is that by bringing attention to the issue, we might get change.

    As you say, another solution is a better range of ETFs sold in Canadian dollars.

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  3. u buy stocks? Ithought you were an indexer?

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  4. The currency spread is worse on smaller conversions. Right now, TDW bid-ask is 1.0122/1.0436 for converting $10,000 US. It is very important that investors pay attention to this issue because currency conversion is costing us big time.

    Thanks for the mention!

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  5. @Dale: I used to trade stocks, now I trade ETFs. Although I won't rule out the possibility that I might sell some stock in my employer that I get through stock options.

    @CC: Yes, the spreads get worse for smaller conversions. We can think of this as a constant spread plus a commission. The smaller the transaction the larger the commission part looks when expressed as a percentage. The main things that need to change are a reduction in both the variable (spread) part and the fixed (commission) part.

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