Is a $5000 Questrade TFSA trading account cost effective? Part 2

Part 1 of this TFSA trading account cost analysis series considered the[costs of a TFSA trading account using data from my recent forex trading][] (forex trading is not allowed in a TFSA, by the way) as a hypothetical case study. I conclude that even if I can trade in my best month, every month, I would still lose money in a TFSA because of the high relative commission versus a limited principal balance. In this second part of the series, I use my recent trading performance data to compare trading a TFSA trading account with a non-registered trading account (i.e. with capital gain tax). Feel free to skip to my conclusion in Part 4 if you don't care for the calculations. As I said in my previous post, the key problem with a Questrade TFSA trading account is the commission with respect to the small contribution limit (\$5000 per year). The only way out of this is to risk more on each trade such that the commission isn't as big as a portion of your cost anymore. I normally risk 0.2% on each trade. In a \$5000 account, that is \$10 risked per trade. With a commission of \$5 per trade, a round-trip commission would also be \$10. So my total risk has doubled. But if I increase my risk to 0.5% of my account, or \$25 per trade. A \$10 commission is reduced to 40% of my total trading risk. As you can imagine, a cost analysis spreadsheet is starting to take shape. It's obvious that the more you risk on a trade (not a suggestion), the less the effect of commission have on you because the commission is a fixed cost. This isn't telling us anything useful so far. So let's take this a step further by conducting a cost-benefit analysis. For that, we compare net profits from a taxed trading account versus a tax-free trading account. Consider the reward with respect to the risk per trade. Step 1. Given each risk amount (e.g. 0.2%), what is my typical reward? In other words, what is my reward/risk ratio in trading? That's easy for me to identify as I've been keeping detailed records of my trading. Based on my data from recent months, my reward/risk ratio is around 2.0. For example, with a risk amount of 0.2% per trade, my average reward is 0.4% per trade. Step 2. I find out how much capital gain tax I'm paying on profit per trade. The capital gain tax in Canada is half the marginal tax rate. Say my marginal tax rate is 35%, my capital gain tax is effectively 17.5% because it is halved. So any profit which I derived from a trade is taxed 17.5%. Step 3. Repeat steps 1-2 for each risk and reward values. Putting the results into a table, we get the following. [caption id="" align="aligncenter" width="361" caption="Risk amount vs. capital gain tax table"][][][/caption] Because the Questrade TFSA trading account (affiliate link) is tax free, the column of tax amount is also representative of the saved dollar between a TFSA and a regular trading account. As such, given a total commission of \$10 for a trade. We can see from the table that the tax saved is more than the commission for anything greater than a \$30 risk (\$60 profit) amount. In more general terms, here's my first finding in this case study. Given a reward/risk ratio of 2.0, the money saved per winning trade in a TFSA trading account will be better than the commission paid if I risk more than \$30 per trade, or the average reward per trade is more than \$60. Notice I highlighted the word "winning". This is merely the first part of a cost-benefit analysis. Unless you can win 100 percent of the time, we need to take into account the money lost when trades don't go as planned (more often than not). We still pay commissions on top of the risked amount for all losing trades. That needs to be factored into our cost-benefit analysis. In my next post in this cost analysis series, I will wrap up my calculations by incorporating simple probability theory to derive my expected profit after all is said and done.

[costs of a TFSA trading account using data from my recent forex trading]: http://www.quantisan.com/is-a-5000-questrade-tfsa-trading-account-cost-effective-part-1/