What it means
When people think about the cost of trading, they often look only at the commission on one trade. But to complete an investment, you normally have to enter and later exit, and each step has costs.
Adding both together gives the round-trip cost, which is the true price of using the market. The costs have several parts.
There is the broker's commission or fee, the spread between the price at which you can buy and the price at which you can sell, and exchange or regulatory charges. For larger trades there may also be market impact, which is the price movement caused by your own order.
The cost is usually expressed as a percentage of the trade value. A cost of 0.22% might not sound like much, but for a trader who completes many round trips a year it adds up quickly.
A strategy that earns 0.15% per trade before costs will lose money at that level. Firms use RTTC when they choose between strategies and between brokers.
A high-turnover strategy needs lower costs than a buy-and-hold approach, because it makes more round trips. Companies that manage investments or hedges also track the cost to judge whether the benefit of a transaction justifies it.
Costs differ by market and instrument. Large, widely traded shares usually have narrow spreads, while small shares, bonds and some currencies can have wide ones.
Costs also rise in volatile markets, when spreads widen, which is when many investors most want to trade. The nuance is that this abbreviation is not standard across the industry.
It is often written out in full, or described as round-trip trading cost or total transaction cost. When you see it in a report, check how the author defines it and which costs are included.
In practice
Real-world examples.
Example
A portfolio manager considers a trade that is expected to earn 0.30% before costs. The round-trip cost is 0.22%, so the expected net gain is only 0.08%. She decides the trade is not worth the risk.
Example
A company treasury team compares two brokers for currency trades. One charges a lower commission but has a wider spread, and the other has the opposite. By calculating the round-trip cost on a typical $1,000,000 trade, the team picks the cheaper broker.
Example
An investor who trades small company shares notices that the spread is 1% of the price. A round trip costs at least 1% before any commission, so he needs a gain of more than that to profit. He decides to hold his positions longer.
Formula
Calculation
RTTC = (commission on entry + commission on exit) + spread cost + other fees
RTTC as a percentage = RTTC / trade value
Suppose an investor trades a $50,000 position. Commission is $25 on each side, so the total is 2 x 25 = $50. The spread cost for the round trip is 0.10% of the position, which is 50,000 x 0.001 = $50. Exchange fees are $5 on each side, a total of $10. RTTC = 50 + 50 + 10 = $110, which is 110 / 50,000 = 0.22% of the position.Case study
Seen in the real world.
Fenwick Capital is an illustrative, fictional firm that launched a short-term trading fund. The strategy produced an average gross gain of 0.40% per round trip, and the managers were delighted with the early results.
When the operations team calculated the costs, commissions and fees came to 0.12% and the spread to 0.20%, giving an RTTC of 0.32%. The net return per round trip was therefore only 0.40% - 0.32% = 0.08%.
With 200 round trips a year on a fund of $10,000,000 and average positions of $1,000,000, the fund paid 200 x 1,000,000 x 0.0032 = $640,000 in costs. The illustrative lesson is that costs can consume most of a strategy's apparent profit. The managers responded by cutting the number of trades to 120 a year and switching to limit orders, which reduced the average spread cost to 0.12%. They also began to report returns after costs in every investor update, so that the headline figure always matched what investors actually kept.
Watch out
Common mistakes.
- Counting only the entry commission and forgetting the exit cost.
- Leaving out the spread, which is often the largest part of the cost for less liquid assets.
- Using the same percentage cost for all market conditions, when spreads widen in volatile periods.
Questions
People also ask.
Why is the round-trip cost more useful than a single trade cost?
It shows what it actually costs to complete an investment, which is the number that has to be recovered before there is any profit.
How can round-trip costs be reduced?
Investors can trade less often, use limit orders, choose liquid assets, and negotiate lower commissions.
Is RTTC a standard accounting term?
No, the abbreviation is used informally, so it is best to define it in any report that uses it.
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