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How you can profit from falling share prices by trading CFDs

by , 08 August 2013

Not only can you trade CFDs to profit from a rise in the market, you can profit when prices take a tumble too. So regardless of what the market is doing, you can use CFDs to profit. Let's have a closer look at a short trade…

Before we get into how a short CFD trade works, let’s take a look at what a CFD is…

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 trade on that goes your way, as explained by FSP Invest’s The Ultimate Contracts for Difference Guide.

A short CFD position that goes your way

After doing a lot of research, you decide to short (sell) Sanlam as you think the share price is about to fall.

On day 1
You decide to short (sell) 1,000 CFDs on Sanlam. Sanlam is trading at R27.40 each.

Your overall exposure is R27,400 (1,000 x R27.40).

If the margin requirement is 10%, you need to put down R2,740 (10% of R27,400) as your initial margin.

As with all CFD trades, you don’t pay STT or STRATE like you do when you buy shares.

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

For day one, the brokerage to open the position costs you R137 (R27,400 x 0.5%).

On day 2…
The next day, the price of Sanlam falls to R26.30/R26.40, so you decide to bank your profit.

There is no daily funding for day 2 as you are selling before the close of the markets.

So to close your position, you buy Sanlam at R26.40.

This means the value of the shares you have exposure to is R26,400 (1,000 x R26.40).

The brokerage to close the position is R132 (R26,400 x 0.5%).

How to calculate your profit for a short CFD trade

Take the closing share value off the opening share value. For our Sanlam example, this gives you R1,000 (R27,400 - R26,400).

The funding cost is R2.63 (R27,400 x 0.035/365). When you short a share, you receive the funding cost.

Your profit is R733.63 (R1,000 + R2.63 + R137 +R132).

This is a 26.77 % return on your initial margin of R2,740 (R733.63 / R2,740).

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

How you can profit from falling share prices by trading CFDs
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