At first glance, prop firm challenges appear fairly simple: achieve a certain level of profit, stick to the rules, and avoid exceeding drawdown limits. But any trader who ever took part in a prop firm challenge knows it's not that easy in practice. There is one more element most novice traders tend to ignore—cost per spread—and how it silently undermines your way to achieving the required level of profit.
Not taking it into account, you might believe you've made more significant steps towards meeting the objective than you have really done.
Why it's not that easy to reach profit targets
For example, you have a prop firm challenge with a $10,000 account and a profit target of 10%. In order to achieve it, you should earn $1,000.
Seems pretty clear, doesn't it? All you have to do is identify setups and conduct trades properly.
But there's one thing many traders usually miss—each of your trades involves some cost due to the spread factor. It accumulates during several trading sessions and quietly decreases your net profit.
Therefore, even though you are making money, you may not be able to approach the required profit target as quickly as you want.
Understanding spread in the context of profit targets
Most people don't even know how to calculate spread in forex. For this purpose, you should combine two factors:
- Gross Profit – your gain shown by the MT5 platform
- Net Profit – your actual profit after deducting the spread cost
The spread cost is the difference between the Bid and Ask prices, which is immediately deducted upon opening a position.
As such, if you are scalping or making several positions per day, you will be constantly incurring this expense.
Let us take a look at the same situation under the circumstances of a competition:
- Limited Account size
- Time constraint
- Set Target Profit
- Every Pip Counts.
Breaking it down with a simple example
If we start with the following assumptions:
- Target profit: $1,000
- Average cost per spread: $3
- Number of trades per day: 10
- Number of trading days per month: 20
Then,
- Daily average spread cost: $30
- Monthly average spread cost: $600
This translates into:
Of your target $1,000, $600 worth of “progress” goes to pay off the friction of trading before anything else!
Now you are up against the bigger challenge of overcoming friction before earning any profits!
Why this matters even more in prop firm trading
Spread is irritating in personal trading, however, in prop firm trading, spread becomes more tactical in nature. Why so? Well because, when you trade through a Forex Funded Account you have all these constraints and one must consider them while trading. You cannot afford huge drawdowns, you cannot overtrade to recover the loss, and finally, you must consider the execution cost.
If your entries are too tight and spread is too high for you, then you are effectively increasing your load by some unseen factor.
What do newbies miss?
Usually, what beginners miss out is:
- Entry approach
- Reward versus Risk Ratio
- Trade Winning Percentage
They completely overlook the Execution Cost factor.
Now let me take an example,
Suppose a trader makes a plan in which he/she sets up:
Target = 10 pips
Spread = 2-3 pips
It means that initially, you would lose out on 20-30 percent of your target before the price starts moving in your favor.
Now if we calculate the cost for 20-30 trades a week. The answer would be very clear.
How to factor spread into profit targets properly
In order to be realistic about your challenge, you have to alter your perspective slightly.
Rather than asking yourself:
- "How much do I need to earn?"
You should ask yourself:
- "How much do I need to earn once I've accounted for the cost of my trades?"
That's really what the question boils down to.
Here's an approach that works well:
- Estimate the average cost per trade
- Multiply by the total number of trades you think you'll execute
- Then add the result to your profit margin cushion
So, if your goal is $1,000 and you anticipate $200-$400 in costs from spreads, your adjusted goal will be $1,200-$1,400.
Spread behavior and its impact on performance
Also, spread is not a constant. It is dependent on:
- Market volatility
- Timing of session
- Liquidity
- Events in news
Thus, even though you may have a favorable average spread on paper, certain conditions will add to your trading costs greatly.
For instance:
- A news spike can double or triple spreads
- End sessions can result in unexpected spread widens
- Exotic pairs can remain expensive throughout the day
This is the reason why most prop traders choose high liquidity pairs such as EUR/USD or USD/JPY during tough times. They seek consistency at the cost of unpredictability.
How successful challenge traders handle this problem
Instead of eliminating the spread completely, prop traders adapt to it. They normally:
- Trade in highly liquid sessions
- Do not overtrade poor setups
- Trade on low-spread instruments
- Make higher RR trades, thus making spread irrelevant
Basically, what they do is ensure that spread remains inconsequential in their trading edge.
Final thoughts
Although spread may seem to be nothing but a minor technicality, it actually ends up dictating the whole course of action when it comes to the prop firm test that you have to pass.
There are no profits which do not take place in the context of cost and therefore, once you understand that you need to measure net results instead of gross ones, everything changes.
All of a sudden, your approach becomes more focused, practical and consistent because ultimately, in order to ace your prop firm test, efficiency is key.
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