This is a good question for anyone who is considering using CFDs within their trading strategy. Equity CFDs not only replicate a share trade but have the additional benefits of leverage and the ability to go short. Using CFDs it is possible to profit from a rising or falling market by only making a small capital outlay.

CFDs are a simple, transparent and flexible way to trade as they mirror the share market.

The best way to illustrate the profit or loss on an Equity CFD trade is through a worked example. There are two techniques that can be used when calculating profit and loss; the exposure and per point method.

For both methods let us assume that we buy 500 XYZ CFDs at a price of \$20, and sell them the next business day at \$21.

Method 1 – Exposure Method

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 DAY 1 Opening Purchase Price \$20.00 Buy Quantity 500 Total Exposure \$10,000 Commission Paid (0.1% of Exposure) \$10.00 DAY 2 Closing Price \$21.00 Quantity sold to close position 500 Position closed \$10,500 Commission Paid (0.1% of Exposure) \$10.50 Overnight Finance Charge* (\$20.5 x 500 x (RBA rate + 2%)/365 \$1.83 (Interest rate is 6.5% based upon the RBA cash rate of 4.5% ) Gross Profit \$500 Commissions & Finance \$22.33 Net Profit (Gross minus commissions & finance) \$477.67

Method 2 -Per Point Method

To determine the profit and loss using the per point method for the example above, simply divide the number of XYZ shares by 100:

500 XYZ shares ÷ 100 = \$5 per point (cent) movement

This means that if the share price increases by 1c or 1 point, the CFD position will profit by \$5 and vice versa if the share price decreases by 1c or 1 point the CFD position will lose \$5.

Traders will often use the per point method to quickly multiply the price movement by the dollars per point to calculate their gross profit.

 Price Movement (from \$20 to \$21) in cents 100 Dollars per point (500shares/ 100) 5.00 Gross Profit 500 Commissions & Finance* \$22.33 Net Profit (Gross minus commissions and finance) \$477.67

Traders may use this method to quickly calculate the amount at risk, therefore making it ideal for placing stop loss and limit orders.

The most accurate and simple way to obtain this information is on the deal confirmations that are sent by your CFD provider in the form of daily statements.

Statements provide clients with daily summaries of their account equity, trading resources available, open positions, unrealized P&L, Trades and Realised P&L.

Using either method will allow you to calculate gains and losses for CFDs.

CFDs provide leverage returns which may not be suitable for all investors.

*Financing is calculated based on the full exposure x annual rate / 365. In this example the financing cost was calculated on a closing share price of \$20.50

Note: if the price of XYZ had fallen by \$0.50 the trader would incur a loss of \$522.33.

By Matt Press, Head of Sales, FP Markets

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18 Share Tips – 15 June 2010

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