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 bank or CFD trading company).
Trading CFDs can make you fantastic gains
. But trading CFDs also comes the risk that you can also incur large losses.
Let’s see what happens when you put a long trade on that doesn’t go your way as explained by FSP Invest’s The Ultimate Contracts for Difference Guide.
A losing long CFD position
After doing a lot of research, you think you’ve identified an undervalued share.
You think that Telkom is going to rise in price. So you call your CFD trader and place a trade for 200 Telkom CFDs.
This is what happens when you open a long CFD trade…
On day 1
You buy (go long) 200 CFDs on Telkom at R37.40 each.
Your overall exposure is R7,480 (200 x R37.40).
If the margin
requirement is 10%, you need to put down R748 (10% of R7,480) as your initial margin.
As with all CFD trades, there is no STT or STRATE
payable like there is on shares.
Let’s see what the result would be at the end of the first day.
For the day, the brokerage for opening the position costs you R37.40 (R 7,480 x 0.5%).
On day 2
The next day, the price is R35/R35.20, after Telkom released some bad results.
You realise that you may have been wrong to long Telkom so you decide to take your losses.
There is no daily funding for day 2 as you are selling before the close of the markets.
You sell your Telkom position at R35.
This means the value of the shares you have exposure to is R7,000 (200 x R35).
The brokerage for closing the position is R35 (R7,000 x 0.5%).
How to calculate your loss for a CFD trade
Take the opening share value off the closing share value. For our Telkom example, this give you –R480 (R7,000 – R7,480.
Your brokerage costs you R72.40 (R37.40 + R35.00).
The funding costs is –R1.64 (R7,480 x 0.08 x 1/365).
Your loss is –R554.04 (-R480 – R72.40 – 1.64).
This is a 74% loss on your initial margin outlay of R748 (-R554.04/R748 x 100).
So there you have it, how a losing long CFD trade works.