Understanding the true cost of an investment and accurately calculating the expected return is crucial for traders and investors. This not only involves the market price of a financial instrument, but also a comprehensive assessment of the total trading costs. These costs can vary based on several factors that we're going to have a look at now, but first, for the purpose of clarity, let's distinguish market price from trading costs.

The market price is simply the price at which a financial instrument is traded in the market. Determining factors for the market price include supply and dynamics, economic indicators, and prevailing market sentiment. Trading costs, on the other hand, refer to the various expenses incurred during the buying and selling of financial instruments. Fundamentally, we can differentiate between two categories of trading costs. Firstly, there are explicit costs. These are the clear direct costs associated with a transaction. They're generally disclosed upfront by service providers and add to the out-of-pocket expenses of the investor or trader. Common examples include broker commissions. These are charged by brokerage firms for executing trades. They can be flat fees or a percentage based on trade volume. Exchange fees, these are incurred for using the infrastructure of a particular exchange, which facilitates the trade.

Regulatory fees and taxes. These are imposed by government entities or regulatory bodies to finance regulatory operations.

Unlike these explicit costs, implicit costs are not directly billed. Instead, they're reflected in less favorable execution prices and can significantly impact the total trading cost, particularly in markets with lower liquidity or during volatile trading periods. Examples include bid-ask spread the difference between what buyers are prepared to pay the bid and what sellers are willing to accept the ask. This spread represents a cost that materializes when entering at the ask price and exiting at the bid price. Market impact, this refers to the effect a single large order may have on the market price of a security. A substantial order relative to the average trading volume of the instrument can drive the price up or down affecting the cost of executing such trades. And finally, slippage. This occurs when there is a gap between the expected execution price and the actual execution price of a trade slippage is influenced by market conditions and timing discrepancies, and can happen regardless of trade size. It's often seen during periods of rapid price movements or when liquidity is limited.