Transaction Cost

Transaction cost is a cost incurred in making an economic exchange or buying/selling of a security. Transaction costs can be divided into three components which are:

1. search and information costs

2. bargaining and decision cost

3. policing and enforcement costs.

In trading, transaction costs have explicit and implicit components. The explicit component includes commission and taxes and the implicit component includes spreads, market impact, and opportunity cost which show up in the prices and we don’t separately pay them. Transaction cost is important to investors as they are one of the key determinants of net returns.

For example, Suppose you purchase 100 shares of ABC stock which are trading at $5 per share from your broker. Your payment of $500 to buy the shares already includes the spread charged by the dealer. Additionally, there are brokerage costs of buying shares which vary from broker to broker. If the brokerage cost is 0.1$/share, then you pay $510 to buy those 100 ABC shares