Here's a tutorial on CFD trading to help you understand how CFD trading works?
We're going to run through an example CFD trade, to show you what CFD trading is all about and the details of how an entire trade runs.
After you finish this article, we would have put together the principles that we talked about in part 1 of this tutorial series such as leverage, transaction costs and position sizing all into practice.
In part one of this tutorial, we went through the advantages of CFD trading and the costs in CFD trading. The transaction costs include the interest for long positions held overnight, commissions or brokerage, and also any slippage you may encounter if you trade stock CFDs that are not very liquid.
So now, we'll work through a CFD trade.
By doing so, we'll appreciate the effect of leverage on our trading results, and see clearly how to calculate the costs in a CFD 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.
So, as you can see, a CFD trade is quite simple in the way it works.
We've gone through a CFD trade from beginning to end. This has illustrated important points about CFD trading for you.
You've seen the effect of leverage in a CFD trade on its returns, as well as exactly how transaction costs such as brokerage and interest for long positions are worked out for a CFD trade. They are pretty easy to understand once you've seen an example.
It is due to the use of leverage, relatively low transaction costs, and convenience of stop losses which are automated, that CFD trading has become a popular trading product.
To find out more valuable tips on trading CFDs, visit the website found in the resource box below.
Kurt Magnussen makes it easy to go from CFD trading novice to learning the keys to successful CFD trading, quickly & easily. To learn more valuable tips and hints on CFD trading, go to this website on CFD trading online tutorials. Go there now to grab your tutorials! |
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