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Resident trader
Telstra: a CFD trade explained
Will Kraa, June 12, 2007
Will Kraa is a full-time trader who will be describing the ins and outs of his trades on CompareShares.com.au. These are all actual trades conducted by Will, using his own accounts at various providers. Note that this information does not constitute a recommendation of any sort.
 Telstra is a stock I trade from time to time in my CFD accounts. It has the advantage of good liquidity and trends lasting for months or years as well as shorter time trends within the larger trends. Since late last year it has been in an uptrend, recovering to the price levels seen during 2004 and early 2005.
As I looked at the chart of Telstra (TLS) on Thursday 31 May (see below, first arrow) it was plain it was in an uptrend, trading above a rising 30 period EMA (Exponential Moving Average) and so more suitable for a long trade.
Short trades will be discussed later and have nothing to do with the time involved in the trade.
What was particularly interesting was that it had on three occasions met resistance at about $4.96, as shown by the line on the chart below. It was actually forming a triangle, which is usually a pattern indicating the trend is likely to continue. After the last time the price had moved to the resistance level it had retreated to a low of $4.76, which was touched on three days running, forming a minor support for the price at that level.
As you can see I like to keep things simple and do not have my charts cluttered with countless indicators which simply confuse and usually add no further information. I used to do that but that was at the time when I made no money. For this trade the price action itself was all I needed to see what I wanted to do.
I decided this was good for a trade and to place the trade with my City Index CFD account. I like their method of giving a price for the size of the trade you want to place. During a time of three minutes the quote window is open giving a buy and sell quote for the size of the trade you request. The prices change to keep up with the market but any time during the three minutes you get the price quoted for a buy or sell order by simply clicking “Buy” or “Sell”. This account was funded with a total of $35,000 in the second half of last year and by now had been traded to about $90,000.
My risk management rules for this account allow me to risk 3% of the balance of the account on any one trade. This is more than I would usually trade, but was appropriate since this account forms only a small part of my overall funds in the market.
This meant that on this trade I could risk $2,700. I decided to place the stop for this trade at $4.75, one cent below the support at $4.76. I was hoping to get into the trade at about $4.80 to $4.83 so the risk per share traded would then be 5 to 8 cents. This meant I could buy between 54,000 and 34,000 shares depending on the price I would have to pay.
The target for this trade was the resistance at about $4.96 which was one and a half to two times the amount to be risked so it would be better to get into the trade nearer to $4.80 and definitely not more than $4.83, so the potential profit was larger than the risk. I prefer it to be at least two times the risk but I felt this was not a high risk trade.
The market on the day (31 May) opened at $4.84. I don’t like trading during the madness which often prevails in the first half hour of the trading day and by 10:30am – half an hour after trading opened - it was trading at $4.80/$4.81 which meant I could buy at $4.81 as there were some hundreds of thousands on offer (when trading I always have a WebIress platform open to show me the market depth – the number of shares being offered for sale at each price and the bids placed by potential buyers).
Quick mental arithmetic with the risk at 6 cents per share showed I could buy about 50,000 TLS, to risk $3,000 on this trade. The market was not offering a huge number at this price but plenty to fill my trade so there was not enough time to get out a calculator and I was comfortable with that amount of risk so I placed the trade. It should be noted that in this case I was somewhat flexible with the percentage of the account I risked since I do have a lot more capital available in other trading accounts (with other providers). Without that I would strictly enforce no more than a 2% risk per trade.
The market only traded at this price for about one and a half minutes and then moved up again and finished the day at $4.86 for an trade which was already in profit.
In the next few days the price continued to rise as expected and by the next Tuesday (5 June, second arrow) had reached the target price. I was able to sell at $4.94 and by the end of the day the price was back to $4.90.
The gross profit for the trade was $6,500 and from this there was commission and interest to be deducted. Commission was just under $500 and interest less than $200 so net profit was about $5,800. With an initial margin of $12,025 you would usually be told by those who promote CFDs that this represents a profit of 48% on the initial outlay but this is not a particularly useful statement to make. It is not possible (or advisable) to use all the margined capital available in a CFD account as this is far too risky and would be guaranteed to lead to margin calls.
But of course the leverage available does make it possible to make far larger trades than would be possible without the use of CFDs and it is useful to note that this trade was a 6.4% profit on the whole of the account over a period of just under five days. It was not the only trade on the account at the time so the profit potential is much more than would be possible trading shares.
It is also necessary to note that while the leverage increases profits it also does wonders for losses and can clean out an account very smartly unless appropriate risk management rules are strictly enforced. If you don’t know how to do this or don’t have the discipline to carry it out then under no circumstances should you use the leverage available in a CFD account.
In future discussions of other trades I will be explaining and illustrating more fully how all this works, so if you don’t understand the risk management employed in this trade then it will become clearer as time goes on.
Calculations for this trade:
- Entry Price $4.81. Stop placed at $4.75. Profit target $4.96
- Risk per share traded $4.81 - $4.76 = $0.06
- Potential profit per share traded $4.96 - $4.81 = $0.15
- Capital in the account $90,000. Risk per trade 3%.
- 3% of $90,000 = $2700
- Number of shares to buy $2,700/$0.06 = 45,000. (As explained I actually bought 50,000 making the amount risked $3,000).
- Trade size at opening 50,000 x $4.81 = $240,500.
- Trade size at closing 50,000 x $4.94 = $247,000.
- Gross profit $6,500.
- Margin required 5% of trade size of $240,500 = $12,025 (I had only one other open trade at the time and so plenty of capital in the account to cover the margin required for this trade).
Explanation of some of the terms used:
Notice that on three occasions on the chart the price touched $4.96 only to retreat again. This price level is called resistance and you can see on the chart that on the day I closed the trade the price briefly broke through this price level to $4.97, but then again fell back.
Similarly on three days before my trade the price had fallen to $4.76 and then moved up again. When this happens such a price level is called support and can be used to set a stop level. If the price falls through support it is likely that the price may fall further and so I would terminate the trade and take the loss as the cost of doing business. Not to do this could mean that the price could fall a substantial amount and lead to a large loss and potentially much more loss than would be healthy for my account. Remember the leverage.
Liquidity is a term used to indicate the amount of trading that usually takes place from day to day in a particular share. Some shares trade at very low daily turnover and if things go wrong it can be very hard to get out at a reasonable price. It is likely it may not be possible to get out at the price set as your stop and you may have to take a much larger loss than anticipated. This makes risk management impossible. So especially when trading CFDs it is necessary to make sure the daily turnover (liquidity) is good enough to accommodate the size of the trade you intend to do - with plenty to spare. It should trade with the required liquidity on a regular basis. My quarter million dollar TLS trade was only a fleabite of the daily turnover but there are plenty of shares where it could be more than the entire day’s trading.
There are lots of shares which have very low liquidity that can be traded on CFD accounts, but are only suitable for very small trades in small accounts. Taking into account the minimum commission payable it becomes questionable if such trades are worth doing at all. It is also doubtful if the very small account sizes encouraged by some CFD providers (starting at a minimum account of $1,000 for instance) are viable for share trading unless no commission is charged. These small accounts can be used for trading Forex but that is another ball game and we will be looking at that later.
Whatever your views, you can discuss this article - or any of Will's articles - on our message board Your 2 Cents.
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