Closely related to the misuse of leverage is the mistake of not understanding how a particular trade will impact your profit and loss. Because of the substantial leverage that is associated with CFD trading, seemingly small outlays can result in large moves in the overall profit or loss of your CFD trading account. This can take some traders by surprise.
Consider a CFD priced at $2.40 that trades on margin of 5%. If a trader wishes to buy 10,000 of these CFDs, the outlay will be just $1,200 as an initial margin ($2.40*10,000*5%). With this relatively small investment of $1,200, the trader will be controlling a position with a face-value of $24,000.
On a position of this size, a price move of one cent will have an impact of $100 on the overall account balance e.g. CFD price increases $2.41 then face-value now $24,100. The simple way to calculate this is to multiply the number of CFDs by the smallest movement in price. This is calculated using the following formula: CFD position size x Minimum Price Movement = Dollars per point.
If you opened a long position in the above mentioned CFD at $2.40 and the price increased by $0.12, you would have made an unrealised profit of $1,200. However, if the price of the CFD fell by the same amount, you would have an unrealised loss of $1,200. Although these moves represent a 100% gain or loss in respect to the initial margin outlaid, the overall impact will depend on the size of your total account.
For a trader with just $1,500 in their account, a trade that results in gains or losses of $100 per $0.01 of price movement will clearly have a massive impact on the overall P&L.
| CFD position size | Price movement | Dollar per point |
|---|---|---|
| $10 | $0.01 | $0.10 |
| $100 | $0.01 | $1.00 |
| $1,000 | $0.01 | $10.00 |
| $10,000 | $0.01 | $100.00 |
However, if the same trade were taken by a trader with $40,000 in their account, the relative impact would be much smaller.
A loss of $1,200 on a $1,500 account would see 80% of the account wiped out. However, a loss of $1,200 on a $40,000 account would reduce the overall balance by just 3%, which is clearly more acceptable.
Traders should be aware of both the impact of a one-point ($0.01) move in the CFD they are trading and how this relates to their overall account.
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