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).
When you put on a CFD trade
, you need to know how it all works and how you calculate your percentage gain.
Let’s see what happens when you put a long trade on that goes your way as explained by FSP Invest’s The Ultimate Contracts for Difference Guide
A long CFD position with a profitable result
After lots of research you decide you are going to buy Standard Bank CFDs. Your research has concluded that Standard Bank’s share price is going to rise over the short term.
So you enter into a long CFD position on Standard Bank.
This is what happens when you open a long CFD trade…
On day 1
You buy (go long) 100 CFDs on Standard Bank. Standard Bank is trading at R112 each.
Your overall exposure is R11,200 (100 x R112).
If the margin
requirement is 10%, you need to put down R1,120 (10% of R11,200) 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 R56 (R11,200 x 0.5%).
Later on the same day, the price rallies higher to R130/R130.20. So you decide to bank your profit and run!
With CFD trading there’s a daily funding charge
for holding contracts. But with this example you don’t pay the daily funding charge as you close out your position before market close.
So you sell your Standard Bank position at R130.
This means the value of shares you have exposure to is R13,000 (R130 x 100).
The brokerage for closing the position is R65 (R13,000 x 0.5%).
How to calculate your gain for a CFD trade
Take the opening share value off the closing share value. For our Standard Bank example, this gives you R1,800 (R13,000 - R11,200).
Your brokerage costs you R121 (R56 + R65).
There is no funding cost because you closed your position before the market closed.
Your profit is R1,679 (R1,800 – R121).
This is a 149.9% return on your initial margin outlay of R1,120 (R1,689/R1,120 x 100).
So there you have it, how a profitable long CFD trade works.