When you are starting to trade CFDs, it might seem difficult to understand the ways that profit and loss is calculated. But there since there is nothing more than basic math involved, new traders can quickly understand the process by seeing a few hypothetical examples at work. CFD trading does differ from traditional shares investment, however, as traders can use margin and leverage to command very large positions with only a small initial deposit. All of the gains (or losses) that result from the trade are yours to keep as if you had paid for the position in its entirety.
Trading CFDs in Rising and Falling Markets
Profits can be made from CFD trades in both rising and falling markets, so the added flexibility of these types of trades will allow you to implement your investment strategy no matter which way the market is headed. Put simply, you can calculate your profit and loss result by subtracting the difference in your assets price from the time your trade is opened to the time it is closed. Once you have this figure, you multiply this number by your position size and subtract your CFD brokers trading costs (the fees required in providing you access to the CFD markets). This give you the total profit or loss calculation for your entire position size.
Here, we will look at some hypothetical examples to see how trader actually unfold. These examples will look at sample CFD trades in stock shares, but the same calculations apply to all asset markets (such as forex, bonds, or commodities).
Trading Example: CFD Long (Buy) Position in Stocks
First, we start with the assumption that the price of YAHOO stock will rise in the next week. To express this view, we will buy shares of YAHOO, which are currently valued at $15. We feel very confident in this view, so we will buy CFD contracts that are equal to 1,000 shares, making the total value of the investment $15,000. We will make this trade using 10% margin (which means that we need only to deposit 10% of the total investment, or $1,500).
The next item to factor-in is the broker costs, which we will assume to be 0.10%. This cost will be tabulated twice (once for the trade entry, once for the trading closing). To calculate these costs, we take the total value of the investment ($15,000 and multiply that by the broker fee (0.10%) and this gives us $15. All together, this makes our total capital outlay equal to $1515.
Next, we will assume that our trade idea was correct, and the price of YAHOO stock was seen rising to $17.50 the following week. How do we calculate profits?
Since we own 1,000 shares of YAHOO and that is now equal to $17,500, we simply subtract this figure from our original investment (17,500 – 15,000 = 2,500). From this we will have to subtract brokerage costs for entering and exiting the trade (15 + 17.50 = 32.50). Thus, our final calculation is $2,500 – $32.50 = $2467.50.
Trading Example: CFD Short (Sell) Position in Stocks
One thing that many new CFD traders do not understand is that you can actually profit when the price of an asset falls. If you are expecting the value of a stock (or other asset) to decrease, you will simple place a SELL position (often called a SHORT position). Here, we will look at how a trader might have reacted to an expected drop in the price of YAHOO stock and to see how a SHORT trade would have progressed.
First, we sell 1,000 CFDs in YAHOO, which are currently valued at $15, making the total value of the investment $15,000. We will make this trade using 10% margin (which means that we need only to deposit 10% of the total investment, or $1,500). The broker fee (0.10%) and gives us an initial trading cost of $15. Our total capital outlay equal to $1515 for our SHORT trade.
Assuming the trade idea was correct, the price of YAHOO stock dropped to $10.50 the following week. How do we calculate profits?
Since we own 1,000 shares of YAHOO and that is now equal to $10,500, we simply subtract this figure from our original investment (15,000 – 10,500 = 4,500). From this we will have to subtract brokerage costs for entering and exiting the trade (15 + 10.50 = 25.50). Thus, our final calculation is $4,500 – $25.50 = $4474.50.
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