Unfortunately, markets and prices don’t always go up. There are periods of time where prices fall and where going long or buying doesn’t work. With CFDs you have the opportunity to profit from a fall in prices as well as a rise in prices. To profit from a fall in prices is said to be going short or short selling.
If a CFD trader believes prices are falling they can sell a CFD first at a high price in order to buy it back later at a lower price. In order to do this they may borrow the CFD from their CFD provider and sell it before buying it back at a later date. The CFD trader would then benefit from the difference in the price they bought and the price they sold the CFD.
This may seem a little complex at first however the concept is that you sell first and buy second, hopefully selling at higher price and buying at a lower price. Some examples may help.
CFD Example – Going short and making a profit
Going short’ is simply opening a short “sell” CFD position to profit from a fall in prices
Steve saw that Lihir Gold (LGL) had broken key support and looked set for a pullback. Steve places a sell order for 35000
LGL shares at the current market price of $2.78. The face value of the trade is $97,300 and the margin rate on STO is 10%. Therefore $9730 ($97,300 x 10%) is required as margin to open the position. The trade is placed and Steve holds a short LGL CFD position with a face value of $97,300
When opening a short position you have received a cash payment for the full value of your short position and receive interest on this amount at the RBA target rate minus 2.25% pa. The overnight interest rate is calculated by dividing the per annum applicable interest rate payable by 365 (days per year).
Assuming that the price of LGL drops by 10c the following day to $2.68 the trading profit will be $3500 which represents a 36% return on Investment including transaction costs.
The Trade in detail
Opening the trade – ‘Going Short’- Selling 35,000 Lihir Gold (LGL)
|
Trader Dealer |
|
|
Price of Lihir (LGL) |
$2.78 |
|
CFDs sold |
35,000 |
|
Commission |
$66 |
|
Total Exposure |
$97.300 |
|
Margin Requirement (5%) |
$9,730 |
|
Total outlay |
$9796 |
Closing the trade – Buying 35,000 Lihir Gold (LGL)
|
Trader Dealer |
|
|
Price of Lihir (LGL) |
$2.54 |
|
CFDs bought to close position |
35,000 |
|
Commission |
$66 |
|
Net Profit from trade |
$8400 |
|
Total outlay |
$9796 |
|
Financing received |
$18 |
|
Net profit |
$8286 |
|
Return on total outlay |
98.64% |
However if the trade had gone against your initial view and you decided to close the position when LGL was trading at $2.82, you would have lost $1514 inclusive of costs.
Tags: CFD, Education, going short, Short Selling, trade
