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CFD Trading Tutorial: Part 2
By Kurt Magnussen
We're going to put it all together by showing you an example CFD trade, so you can easily see how CFD trading works.
The knowledge that you've gained in part 1 of this series, about how CFDs have become popular because of the ability to go long or short on a large range of stocks, the use of leverage, and how to calculate transaction costs will be put into practice in this example trade.
The transaction costs of CFD trading, as a reminder, includes the interest for long positions held for more than one day (but paid for short), commissions (if any, depending on your provider) and also slippage, depending on the market that you're trading.
Let's see all this in action by going through our example trade.
Firstly let's assume some position sizing rules.
Let's say that the float that we have available is $10 000 cash. And let's say that our CFD provider has 10 to 1 leverage, making our leveraged float equal to $100 000.
Plus let's say that we're using a fixed trade size type of position sizing model. That is, we put in a fixed amount, say $10 000 into each CFD position.
OK, so now let's say that we are now going long on a CFD where the current market price is $5.70.
So how many CFDs would we buy? Assuming a $10 000 trade size, the answer would be 10 000/5.70, which = 1754 CFDs.
Now for our protective stop loss. Let's say that we have a stop loss of $5.50. This means that if the price falls to or below that price of $5.50, then we'd exit this trade. And if we do, it would be at a loss of 20c per CFD.
So let's assume that we get into the trade, and that the trade does go in our direction, which is up.
Then, a few days later, the trade is still going alright, and let's say that the CFD price is now $5.90. And say that according to our system rules, it's time to move our trailing stop up to $5.65.
Then, the trade goes along for a few more days, and then the CFD price rises to $6.32. And again, let's say that according to our system rules, we now move our trailing stop to $6.20.
Then finally the CFD price falls through our trailing stop loss of $6.20, therefore getting us out of the trade at $6.20, assuming no slippage as this was a CFD that had a decent amount of liquidity.
The total duration of trade was 14 days including both the entry and exit days.
So the difference between our entry and exit prices is = $6.20 - $5.70, which is $0.50.
Our gross profit for this trade is therefore = (difference between entry and exit price) x (number of CFDs), = 0.50 x 1754, = $877.
That's out gross profit. What about the net profit after costs?
To work out our net profit, we'll need to now calculate our transaction costs and then take it away from out gross profit.
Our transaction costs = commission + interest.
1. Commission
Let's say that our CFD broker's commission is say $15 each way, or 0.15% of the trade size, whichever is greater. In our trade that we've described above, where our trade size was $10 000, our total commission would be $15 times 2, which comes to $30.
2. Interest
Let's say that our CFD provider's interest rate charge for long positions held overnight is 7.5% or 0.075 per annum. To calculate the actual cost for our trade that we've just done, we'll need to make it "pro rata", and then multiply it by our 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.
Therefore our net profit is:
Net profit = gross profit - (commission + interest)
= $877 - (30 + 28.76)
= $818.24
So that's $818.24 over 14 days, based on $1000 which is the margin required for the trade. The ROI, or return on investment, calculated as a percentage of margin used, is therefore 82% over 14 days.
So now you've gone through an entire CFD trade. Well done!
Remember that for short positions, the interest is paid to you, not charged, so will reduce rather than contribute to the transaction costs.
Something else to note here. The interest charge in our example is slightly simplified because CFD brokers usually calculate the interest charge on the marked to market value of the position on a daily basis. If we did calculated the interest cost using the highest position size ever reached during the trade of 11085.28, the interest would be $31.89. Therefore the real interest cost would be a figure between $28.76 and $31.89. The initial estimate as you can see, is close enough.
A CFD trade is quite simple in its mechanics once you've seen a trade in action. You profit from the difference in price, and it makes good use of leverage.
It is really due to the leverage available, the relatively low cost, and use of automated stop losses, that CFD trading has its advantages.
About the Author
Grab some more valuable hints and tips on CFD trading, by going to Kurt's website. There, you'll learn more about CFDs, how to choose CFD systems, and how to choose CFD brokers. Go to http://www.thecfdtrader.com/cfd-brokers-online.php
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