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Financial Transaction Tax and Slippage and Commission

Posted by David Bean on

The Financial Transaction Tax also known as the Wall Street Act is big news today. Some of the politicians in Washington DC continue their efforts to bring a transaction tax to Wall Street. The proposed tax of 0.1% doesn't sound like a big deal right? The way I understand it though, would eliminate the current opportunities to day trade the financial markets and would have unintended consequences to volatility. 

Their goal is to raise revenue since "Wall Street can afford it". The potential 70% capital gains tax is not enough.

In my estimation, 99.9% of the daily trading volume generates less than 0.1% in profit per trade. The best day trade algorithms that trade with any frequency at all (2-3 times per day) would at best make a $100 average trade profit per futures contract, while most algorithms would make much less than this and even as low as $15 - $20 average trade profit per futures contract after current transaction costs of slippage and commission while the high frequency traders and market makers make only pennies per trade.

The proposed tax of 0.1% would be based on the value of the contract traded and not the profit. The list below shows the cost per contract traded based on the ten popular futures contracts based on closing prices from March 4, 2019.

Based on this table, 99.9% of traders, including market makers, could no longer afford to trade their short term algorithms. The commercials that needed to trade could still trade but the illiquid order book would create much more volatile markets as it would take much less volume to push the markets much further. 

The lack of liquidity could push commercial hedgers out of the market as the risks associated with a thin order book and less liquid markets may not be worth the risk in placing the same number of hedges if the risk to place the hedge is greater than the benefit of the hedge.

Those who support this tax bill don't understand the difference between trading volume and liquidity in the order book.

The goal of raising revenue would be diminished and the markets would actually see even greater volatility including flash crashes and spikes. 

Over time, traders would adjust and recognize new opportunities. Less liquid markets would create much larger price moves and the average trade profit of good algorithms would be much higher and enough to absorb the cost of the transaction tax. Much fewer contracts (less trading volume) would have to be traded and more profits could potentially be made. 

The goal of less volatility and more revenue would not be achieved in either case and the politicians would have even less of what they want.

Terry Duffy called this a tax on liquidity. Jeb Hensarling says this is a goal to punish high frequency traders and finance socialism. It will increase cost of hedging and will hit the consumer.

Terry Duffy said that average trade profit for market makers is about $0.20 per contract. They would have to pay a $139.58 tax to make $0.20.


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