Introduction To CFD (Contracts For Difference) Trading – Part 2

Welcome to part 2 of this 2 part series on Contracts For Difference (CFD) trading.

If you're new to CFD trading, you would've found out in part one all about why people trade CFDs over (or as well as) other investment instruments.

The reasons included firstly, the leverage, secondly, the high number of shortable stocks, and thirdly, the ability to use automatic stop losses, and more.

We also went through the transaction costs of a CFD trade. These are commissions (which may be zero for some providers), and the interest charges for overnight held long positions.

So in part 2 right now, we'll go through an example CFD trade, and see the use of leverage and actually calculate the costs in a CFD trade.

So we're putting it together to see how it all works.

Here we go.

Let's say that we have a cash float of $ 10 000, leveraged up to $ 100 000, as our CFD provider provides 10 to 1 leverage. And let's say that we'll put in $ 10 000 into each trade.

For this example, let's say that we bought some CFDs at a price of $ 5.70. With a trade size of $ 10 000, the number of CFDs we would've bought would be 10 000 / 5.70 = 1754.

And let's say that we have a stop loss at $ 5.50, which means that if the price falls to or below $ 5.50, then we'd exit this trade at a loss.

Let's assume the trade goes well, and that the CFD price is now $ 5.90. And let's say that we now trail our stop up to $ 5.65.

Several days later, the CFD price goes up to $ 6.32, and our trailing stop is moved up to $ 6.20. Then finally, the CFD price falls through the stop loss of $ 6.20, exiting us at $ 6.20.

The whole trade took 14 days.

The difference in the price from entry to exit = $ 6.20 – $ 5.70, which comes to $ 0.50.

Our gross profit therefore = (difference between entry and exit price) x (number of CFDs), which is 0.50 x 1754, which comes to $ 877.

Let's now calculate our costs, to work out our net profit.

Our costs = commission + interest. Let's calculate each in turn.

Let's assume that our CFD provider's commission is $ 15 in and $ 15 out, or 0.15% of the trade size, whichever is greater. In this case, where put trade size was $ 10 000, our commission would be $ 15 + $ 15, which comes to $ 30.

And let's assume that our provider's interest rate charge for long positions held overnight is 7.5% or 0.075 per annum. To calculate how much this is for our trade, we need to make it "pro rata", and then multiply it by the trade size.

Interest = (interest rate for long position per annum) x (days in trade / 365) x (trade size), which is 0.075 x 14/365 x 10000, which comes to $ 28.76.

Thus our net profit = gross profit – (commission + interest)
= $ 877 – (30, 28.76)
= $ 818.24

That's a pretty good result in such a short time!

Note that for short positions, interest costs are paid to you, not charged, so will offset rather than contribute to the costs. Also realise that the interest charge is slightly simplified because the interest for many CFD providers is calculated on the market value of the position on a daily basis. If we calculated the interest cost using the final position size of 10818.24, the interest would be $ 31.28, which is very similar. So the real interest cost would be between $ 28 and $ 31.

So that's how a CFD trade is done! Note that the margin required for the trade was $ 1000, and the trade size leveraged up was $ 10 000. The return on investment, as a percentage of margin used is therefore 82%.

Now you know how CFDs work, and an example trade to illustrate many important aspects of CFDs.

To summarise, you've seen leverage at work, as well as exactly how transaction costs are calculated for a long CFD trade. CFD trading is attractive because of the use of levergae, relatively low costs, and the ability to go long or short, to take advantage of, and profit in rising as well as falling markets.

To learn more about CFD trading, including how to assess CFD trading systems, and what the current interest is about CFDs are about, visit the website described in the resource box below.



Kurt Magnussen