CFDs: going long vs going short

This guide will help you understand the concept of going long vs going short with CFDs.

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Disclaimer: This information should not be interpreted as an endorsement of futures, stocks, ETFs, CFDs, options or any specific provider, service or offering. It should not be relied upon as investment advice or construed as providing recommendations of any kind. Futures, stocks, ETFs and options trading involves substantial risk of loss and therefore are not appropriate for all investors. Trading CFDs comes with a higher risk of losing money rapidly due to leverage. Past performance is not an indication of future results. Consider your own circumstances, and obtain your own advice, before making any trades.
When trading, you’re likely to come across the terms “going long” or “going short”. You might also hear people talking about “shorting the S&P/TSX Composite Index”, which means they expect the value in the S&P/TSX Composite Index to fall and therefore are adopting a short position, which means you’re selling ahead of it. It’s possible to “sell” even if you don’t own the underlying asset, we go into this in some detail below.

What does it mean to go long?

Going long is the purchase of an asset. You might choose to do this if you expect the prices to rise in value, which means you can then sell at a later date, for a higher amount.

What does it mean to go short?

Going short is usually the sale of an asset. It’s possible to do this with an asset that you don’t actually own (confusing, we know!). You might choose to do this if you think the value of the stock will go down.

How can you sell something you don’t own?

You can take a short position even when you haven’t bought the stocks. This is done by borrowing the stocks from your provider. You borrow them and sell them when you think the value is about to decrease, then purchase them again at the decreased price to return to your provider.

What is a contract for difference?

A contract for difference (CFD) is a contract between you and your broker based on the value of a particular asset. The amount of profit or loss you make is determined by the “entry” price (the price when you take out the contract) and the “exit” price (the price when you end the contract).

You can trade CFDs in assets such as shares indexes, shares and commodities such as gold or oil.

CFDs are normally purchased on a margin basis: every financial derivative has its own percentage. The margin can be identified as a deposit for the purchase of the particular asset. If you buy 100 shares at $5 each and the margin is 5%, you will pay ($5 x 100) x 5% which equals to $25. The shares total is $500, but you only need a margin of $25 to open the position.

Canadian restrictions on using leverage

CFD trading is legal in Canada but it is heavily regulated by the Investment Industry Regulatory Organisation of Canada (IIROC). IIROC applies restrictions on using leverage. The limits are meant to reduce the risk to traders but they also mean that you may not be able to borrow as much as you could in other countries.

Example
Long vs short

For example, stock XYZ has a current trading price of $5. Let’s say that you expect the price to increase and you’ve got $5,000 handy. You could choose to invest in 20,000 shares, totaling $100,000 with your margin of 5%. .
If the price over a two week period goes up to $5.10 per share, then the shares that you own will be worth $102,000, which is a $2,000 gain. You can then sell at this price to realize the gain.
Please keep in mind that this is gross profit and that you have to subtract the cost of the trade being open for two weeks and also the trading commissions due. At the end of this calculation you will get the net profit from the long position.

The short position

If you think the value of the asset or security is going to go down then you can choose to take a short position. Going back to our example of XYZ, let’s say it trades at $5 and you expect that it will decrease in value.

Using the same figures as before, with $5,000 and a 5% margin, you can get access to 20,000 shares of XYZ at a total value of $100,000. To take a short position or “short” XYZ, you’d sell the shares.

Let’s assume that the stock decreases to $4.75 in a couple of weeks. Your 20,000 shares are now only worth $95,000, as expected, so you can buy them back at $5,000 gross profit.

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How interest rates affect your position

One of the main things that impact you when you take a position is the interest rate. If you take a long position (or buy) then you may have to pay interest for positions held overnight.

If you choose to take a short position (or sell) then you’ll have interest paid to you if you hold the position overnight.

There isn’t a universal interest rate that all providers use, so it’s worth checking with your provider how much it charges for this. In general, the provider will have some kind of reference rate and will add a specific percentage when going long and subtract it when going short.

What’s the difference between going long and going short?

The difference between the long and short positions lies basically in the interest rate that has to be subtracted from the gross profit in the case of the long position and added in the case of the short position.

Here you can see an example on how the long and short positions work:

Long OptionShort Option
Interest Rate5%5%
Commission Rate0.1%0.1%
Value (present)$150,000$150,000
Fee CFD Position (open)$150$150
Future Value$160,000$140,000
Fee CFD Position (closed)$160$140
Profit – gross$10,000$10,000
Minus fees$310$290
Interest subtracted (long)$257
Interest added (short)$235
Profit – net$9,433$9,945

In this particular case you could make a higher profit from the short position because of the “interest” factor.

Let’s assume that in both cases you get a loss. In the long position you have to add the interest, while in the short position you need to subtract the interest. In such cases going long will minimize the loss, whereas going short will increase the loss.

Using leverage could also boost your profits as much as your losses: it would be better to limit this financial tool if you are a newbie.

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