Slippage is defined as the difference between the price expected to pay and the actual price paid. The difference between the bid price and the ask price is known as the spread. If a stock is quoted as Bid 25.48, Ask 25.51, the spread is 3 cents. If you were to put a buy market order in, you would be filled at 25.51 and higher (depending on the size). If you put a sell market order through you would be filled at 25.48 and lower. If you purchased at 25.51, you would have to have to wait until the bid rose to 25.51 (or higher when brokerage fees are considered) just to break even.
Stocks are said to be ‘liquid’ when their average daily trading volume is very high and, they trade with only 1-2 cent spreads eg. Bid 25.50 Ask 25.51. If a stock is not very liquid it may have a spread of up to 20 cents.
The Importance of Low Brokerage Fees
Another major reason that I chose to trade the US markets rather than the New Zealand or Australian stock exchanges is discount brokerage fees in the USA are considerably less. The brokerage fee in New Zealand is about $25 each way (up to a limit) and then a percentage of the total above that. In comparison, www.interactivebrokers.com in the United States of America only charge 0.5 cents per share with a minimum of $1.00. To show how important low brokerage fees are when trading, look at the following example:
Say you purchase 200 shares at $10.00 each in NZ. The total cost will be $2025.00 (200 x 10.00 + $25.00 brokerage fee).To sell the same shares to breakeven, the shares will need to be sold for $10.25 per share. 200 x $10.25 - $25.00 = $2025.00. This means the share price has to increase by 2.5% just to breakeven.
Take the same example in the US using www.interactivebrokers.com . The brokerage fees on 200 shares of $10.00 stock is 0.5 cents per share for a total of $1.00. To breakeven the stock will need to be sold at a price of $10.01 for a total of $2002.00. This means the price only needs to increase by 0.1% before the stock can be sold to breakeven.
If you made on average one round-trip trade per day, after one month, or 20 trading days in New Zealand you would have paid $1000.00 in brokerage fees. The equivalent In the US you would have paid $40.00 worth of brokerage. Over a year the difference is $12,000.00 in NZ vs $440.00 in the US – huge difference!
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