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Types Of Markets Part 5: Shares Part 3

Share CFD’s

Firstly, CFD stands for “contract for Difference “ which, in English, means the contract is between the trader and the market maker to settle the difference between the entry and exit price in cash. I.e. the trader does not hold any of the rights associated with the stock other than the dividend. If we buy, we are entitled to receive the dividend and if we sell, we will have to pay the dividend.

when you sell a CFD you borrow the instrument from the market maker and then sell it into the open market and therefore the market maker is entitled to any divi that is paid out. As we have sold the instrument the new holder/buyer will receive any divi, but the market maker is also entitled to the divi, as he in fact holds the instrument you have borrowed. This leads to a gap which we as the seller must fill by paying the dividend to the ultimate holder. That is a bit of a mouthful but re-read it slowly. This remains true of any dividend paying instrument such as Stocks or Indices.

One CFD = one share (this article mainly focuses on stocks, but the idea remains true for any CFD), the trader places a good faith deposit (margin) with the market maker in order to gain exposure to the share and we pay SWAP which is in effect a cost of holding the exposure value of the trade.

Exposure = number of shares x share price. If you hold 1.0 (R1 per point) contract you then multiply that by the current share price to get the exposure value. The SWAP changes regularly and is determined by the broker. On Cloudtrade with Blackstone futures you can trade international shares such as Tesla, VW etc. there are over 600 share cfd’s available there.

With so many trade choices available traders must know exactly what they are looking for in a trade. The are many ways to pick a trade which is why we as traders must know exactly what we are looking for in a high probability trade.

Example

TREND Rule:

21 ema is above 89 ema means the trend is up and I am looking for longs.

21 ema is below 89 ema means the trend is down and I am looking for shorts.

8 Ema crossing 21 ema in the direction of the current trend is trend continuation.

SETUP Rule 1:

21 crossing above 89 yesterday means the trend has changed from down to up and I enter my first long position once today’s price moves above yesterday’s high.

SETUP rule 2:

The trend is up and 8 ema closed above 21 ema yesterday I enter my second long position when price moves above yesterday’s high.


STOP LOSS

Setup 1: last swing low before 8 crossed above 21.

Setup 2: Last swing low before 8 crossed above 21.

Trailing stop: move stop loss up when setup rule 2 occurs or a clear resistance level is broken.

 

 

Trailing stop moved to new support after price broke and closed above resistance.

 

 

Trade setup 2 was triggered when price didn’t break below support and the 8 crossed below 21 then crossed up again. That event also triggered a new trailing stop level at the new swing low.

 

Position sizing

For physical shares in a long-term portfolio the stop loss can be the last swing low before the 21×89 happened. The sizing of long-term trades in physicals is reasonably easy as the money you use to purchase is also the maximum risk. You can only lose what you put in.

The idea of long-term holdings is more about buying for dividend yield over the next 10-20 years and the only reason to sell would be that the company no longer pays out a dividend or something important has changed.

One example is when Mittal SA “forgot” to renegotiate the contract for iron ore from Kumba. The price jumped from cost plus 3% to market related and basically wiped-out Mittal’s profits.

So, on long term holdings, there is often no fixed stop and the investor will follow the fundamentals more closely, sizing is, therefore,  managed by some portfolio diversification rather than risk in one asset.

 

When we start trading with leverage this changes a lot, which is why long term investors can struggle when moving into CFD’s.

 

I will use setup 2 to make it simpler to calculate.

Assuming an account of 100k:

Entry price is around 168.57 per share (high of crossover candle)

Stop loss is around 148.02 (swing low)

Now we must choose a max risk percentage of account balance. I’m going to use 3% for a stop loss amount of 3000 (3% of 100k) on this trade.

 

How many shares can I buy?

 

The difference between entry price and stop loss is 168.57 – 148.02 = 20.55

My risk is 3000 therefore I can divide 3000 by 20.55(risk per share) = 145 shares

So I can buy 145 shares and if price hits my stop level I will lose 145*20.55 = 2979.75 in total.

 

The hardest question is how much am I prepared to lose on one trade, the rule of thumb says 2% traders generally choose somewhere between 1% and 5% per trade on leveraged products.

 

Next time I will discuss how to use CFDs to trade for dividends.

 

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