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CFDs uncovered: What happens when you short a share that starts to rise in price

by , 08 August 2013

One great advantage of CFDs is you can sell (short) them as well as buy, so you can profit whether the market rises or falls. But what happens if you're shorting a share and the price starts to rise? Let's look at what happens with a short CFD trade that doesn't perform the way you want it to…

A contract for difference (CFD) is what’s known as an over the counter (OTC) derivative because you don’t trade it through an exchange (like a share), but through a bank or company who provide CFD trading.

When you trade a CFD, you agree to exchange the difference between the open and close price of the contract with the market maker. The market maker is the bank or CFD trading company you trade through.

Let’s see what happens when you put a short CFD trade on that goes against you, as explained by FSP Invest’s The Ultimate Contracts for Difference Guide.

When a short CFD trade comes back to bite you

After watching the commodity market closely, you decide to short (sell) Kumba.

Let’s see what happens when you open a short CFD trade…

On day 1
You short (sell) 100 CFDs on Kumba. Kumba is trading at R456.

Your overall exposure is R45,600 (100 x R456).

If the margin requirement is 10%, you need to put down R4,560 (10% of R45,600) as your initial margin.

As with all CFD trades, there is no STT or STRATE to pay like there is in shares.

Let’s see what the results would be at the end of the first day…

Your brokerage for opening the position costs you R228 (R45,600 x 0.5%).

On day 2
The next day the price has risen drastically due to stockpiles of iron being much lower than first thought. Kumba’s share price soars.

Kumba is now trading at R469.90/R470. So you decide to take your loss before the situation gets worse.

There is no daily funding cost for day 2 as you are closing your trade before the close of the markets.

You then exit your position at R470.

This means the value of shares you have exposure to is R47,000 (100 x R470).

The brokerage for closing the position is R235 (R47,000 x 0.5%).

How to calculate your loss from your short CFD trade

Take the closing share value off the opening share value. For our Kumba example, this gives you a loss of R1,400 (R45,600 – R47,000).

The brokerage costs you R463 (R228 + R235).

There is no funding cost for the second day as you closed the position before market close.

The funding charge for day one is R4.37 (R45,600 x 0.035/365). You receive this as this is a short trade.

Your loss is R1,858.63 (-R1,400 – R463 + 4.37).

This is a loss of 40.76% on your initial margin outlay of R4,560 (1,858.63/R4,560 x 100).

So there you have it, how a losing short CFD trade works.

CFDs uncovered: What happens when you short a share that starts to rise in price
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