eToro CFDs for Social Trading: the characteristics

 

In the post CFD for dummies we treated in simple terms what are CFDs and how they work. In this lesson, instead, we will focus on the characteristics of the eToro CFD, with which you can trade with Social Trading on the famous and eponymous platform.

 

The characteristics of eToro CFD

 

You can find the terms and conditions of all the CFDs treated by eToro at this link.

Here is an excerpt of the tables.

 

etoro CFD shares

 

– EToro CFD on Shares

 

CFDs on shares have as underlying asset the shares of publicly listed companies. Currently eToro allows to negotiate the main market stocks of:

  • Frankfurt
  • London
  • New York: NYSE and NASDAQ

The characteristics of the CFD on shares are very similar to those of the other underlyings, with some extra particularities.

 

Commission Cost

 

The broker eToro do not impose any fees. Its profit comes from the enlargement of the bid-ask spread. As you can see, for each underlying stock, the spread applied by eToro varies. The reason for these differences can be identified in:

  • different share price;
  • volatility;
  • liquidity.

 

Let’s take a practical example to understand what weight to give to the individual values, considering Apple, which is the first that appears in the table above.

Opening a CFD position on APPLE, with the application of a spread of 8 pips, you have to imagine a situation like this.

On the NASDAQ market, where the underlying shares are traded, Apple has a book like this:

bid                                         ask

126,50                                  126,51

Spread 1 pip

 

If these passages are not clear, please read our lesson on the book.

So, in practice, on the NASDAQ market, to buy Apple shares you are required a disbursement of $ 126.51 (ask price), and in case you wanted to sell it instead you will receive $ 126.50 (bid price), plus the commissions charged by brokers.

Working instead with the eToro CFDs you will have a situation like this:

bid                                         ask

126,46                                  126,54

Spread 8 pips

 

As you can see from the example, the distance between bid and ask is increased. This simple widening of the spread allows eToro to gain from your trading, and you to be in the market with the benefits listed above.

EToro is not a Market Maker kind of broker, because it does not create a virtual marketplace, but it’s not even an ECN, because customer orders are not sent directly to the market (read here to learn about the different types of brokers).

It is a hybrid of both conditions. Essentially, eToro has a brokerage policy for which it covers your CFD transactions with real positions on the real market, through markup operations.

 

What is meant by markup?

In practice, as you saw, eToro applies a spread higher than the actual underlying market, which allows it to profit from its brokerage business.

Therefore, when you open a long position on the APPLE stock, eToro positions itself first in a long position, but on the underlying market (i.e. it buys physically APPLE on the Nasdaq market), and then it opens for you a CFD position, adding the spread. Obviously all this is done in fractions of seconds.

 

Leverage

 

Understanding the logic behind the application of leverage will help you understand how to calculate profits and potential losses.

You can operate on CFD shares with a lever from x1 to x5.

Let’s examine two case studies:

 

Leverage: x1

Investment: $ 50

Purchase price: $ 126.54 (ask price of our hypothetical book)

Underlying: APPLE

 

Equivalent share value controlled: ($ 50 * 1 leverage) / $ 126.54 = 0.39 units

Those that eToro calls units are, in fact, for this type of CFD, shares.

With a x1 leveraged position and an investment of $ 50, you are commanding a value of 0.39 APPLE shares.

Should you sell the CFD at $ 130, the price change would be as follows:

$ 130 – $ 126.54 = $ 3.46

Since you have not made an investment for the equivalent amount of an entire share, or, as eToro calls it, a unit, the profit of $ 3.46 must be multiplied by the corresponding equivalent unit, then:

$ 3.46 * 0.39 units = $ 1.3494

To sum up, if you had invested $ 126.54 you would have earned $ 3.46. Having invested $ 50 with leverage x1, you earned $ 1.3494.

 

Leverage: x5

Investment: $ 50

Purchase price: 126.54 (ask price of our hypothetical book)

Underlying: APPLE

 

Equivalent share value controlled ($ 50 * 5 leverage) / $ 126.54 = 1.97 units.

So with a x5 leveraged position, and an investment of $ 50, you are commanding a value of 1.97 APPLE shares (almost two shares).

Should you sell the CFD at $ 130, the price change would be as follows:

$ 130 – $ 126.54 = $ 3.46

 

But, as before, the value of your operation does not correspond to a share, but to almost 2, therefore the profit of $ 3.46 must be multiplied by the corresponding equivalent unit, then:

$ 3.46 * 1.97 units = $ 6.8162

To sum up, if you had invested $ 126.54 you would have earned $ 3.46. Having invested $ 50 Leverage x5 you earned $ 6.8162

This is the power of the CFD and of the ability to use leverage. From this, however, derives also possible risks if you do not know how to operate as a Social Trading professional.

 

Costs for Overnight operations

 

A negotiation can be closed within the day or be kept open for several days. In this last case, with the eToro CFD contract on shares, there is an overnight commission, variable depending on the underlying or whether you are long or short.

The overnight commission is calculated at 17:00 of New York. You can check the commissions values from their tables. Here’s how to do the calculations.

Taking the previous example:

 

Leverage: x1

Investment: $ 50

Purchase price: $ 126.54 (ask price of our hypothetical book)

Underlying: APPLE

Days of position open: 3

Overnight Commission: 0,025 (according to the table, “buy” section, since you’re long)

 

The overnight commissions are calculated daily.

Assuming to be at 17:00 EDT of the third day, the calculation to be done is:

 

$ 0.025 * 0.39 units = $ 0.00975

$ 0.00975 * 2 (number of nights) = $ 0.0195

Ultimately, if to close the position we would have taken three days, the final profit would have been:

$ 1.3494 – $ 0.0195 = $ 1.329

 

Being at X5 leverage instead…

 

Leverage: x5

Investment: $ 50

Purchase price: $ 126.54 (ask price of our hypothetical book)

Underlying: APPLE

Days of position open: 3

Overnight Commission: 0,025 (according to the table, “buy” section, since you’re long)

 

0,025$ * 1,97 units = 0,04925$

0,04925$ * 2 (number of nights) = 0,0985$

Ultimately, if to close the position we would have taken three days, the final profit would have been:

6,8162$ – 0,0985$ = 6,7177

 

The dividends with the eToro  CFDs

 

Shares have the dividend variable, that is the profit distributed by the company to its shareholders. Operating with CFDs, actually you are not a shareholder of the company since you only have a contract that makes you gain or lose in relation to price fluctuations of the underlying.

It would be normal not to expect any dividends using CFDs, even for a long period.

With the eToro CFDs, however, the dividend is actually distributed.

If you are long on the CFD of a company when it decides to pay dividends, the dividend amount will be credited to your account in relation to the units covered with the investment.

In order to be accredited to the receipt of dividends you must be long on that precise CFD by a certain time, i.e. 17:00, New York time, on the day before the payment of the dividend itself. In practice, if you had the order still open the day before at 17:00, you will receive your dividend.

 

E.g.: The company APPLE deliberate a dividend of $ 3 per share held.

The buyer of Apple CFDs with 34.3 units will get a credit equal to:

34.3 units * $ 3 = $ 102.9

 

If instead you were a seller of the Apple CFDs with units equal to 34.3 you’ll get a charge (a loss) equal to:

-34.3 Units * $ 3 = $ -102.9

Although this thing might leave some doubt, you must also consider the fact that after a payment of dividends, the shares value of a company the next day usually drops down, as a simple matter of total economic value decreased. Therefore, the short order could easily gain some profit, while the long one could easily lose some.

 

Social Trading CFD

– EToro CFDs on indices

 

The CFDs on indices have for underlying the indices of the main trading venues, i.e. the so-called exchanges.

The calculation logic for the application of leverage and overnight commissions are the same of the shares. The difference is that on the indices leverage is from x2 to x100.

 

– EToro CFDs on commodities

 

CFDs on commodities are not so many. EToro currently limits its offer to gold, silver and oil.

As for the CFD on the indices, permitted leverage goes from x2 to x100 and the calculations follow the same logic described in the CFDs on shares.

 

– EToro CFDs on currency pairs

 

The list of currencies offered by eToro through its CFDs is very wide. The leverage range from a minimum of x2 to a maximum of x400.

The peculiarity you can find on currencies is that in some cases the overnight commissions can be positive. This is because the currency you’re buying may have a higher interest rate than that you’re selling.

Practical example with EUR / USD.

Euro pays interest of 0.05% annually;

Dollar pays interest of 0.25% annually.

If I sell EUR / USD, I sell euro and automatically buy dollars, therefore I pay 0.05% and I gain 0.25% per year.

Therefore I gain:

0.25 – 0.05 = 0.20% per year.

The value is multiplied by the units, dollars in this case, of value and divided for 365 days, thus obtaining an amount of credit for each day of overnight.

Obviously, by opening a long position on EUR / USD the calculation should be reversed and you will pay the daily interest in the form of negative overnight commission.

 

Margin with eToro CFDs

 

As you may have noticed, I have talked a lot about margin blocked on the account as collateral, but in the working examples with eToro I have not mentioned it at all.

I didn’t do it because the eToro policy of simplification does not foresee the management of the positions in the form of blocked margin, but in terms of investment, i.e. as investments with a certain leverage to control the operation.

To clear all up, let’s start with understanding how much capital your controlled in the previous example with X5 leverage.

 

The details of your operation are:

 

Leverage: X5

Investment: $ 50

Purchase price: 126.54 (ask price of our hypothetical book)

Underlying: APPLE

 

The equivalent value you are controlling with an operation with these characteristics is:

($ 50 * 5 leverage) / $ 126.54 =

$ 250 / $ 126.54 = 1.9756 units

1.9756 units * $ 126.54 (market price) = $ 250 equivalent value

 

Simplifying the operation, obviously the result is obtained by multiplying your investment for the leverage value:

$ 50 * 5 leverage = $ 250

 

Therefore, in a nutshell, if the leverage used is, for example, X5, the margin normally required by a broker is equal to 1/5 (= 0.20), or 20% of the equivalent operation. If it were x10, it would be 1/10 (= 0.10), or 10%, and so on. The greater the leverage, the more the margin requirement decreases.

Applying the 20% to the transaction of $ 250 you get a result of $ 50, which corresponds precisely to the capital blocked by eToro so you can negotiate the CFD with the characteristics described above.

By its own choice, however, eToro does not talk in terms of margins, an issue that, as we have seen, would imply some reasoning and calculations. The eToro attempt is to make things easier for the inexperienced investors.

EToro turns the margin blocked on the account as collateral into a capital taken off of the account and invested to finance the operation, thus giving the possibility to the less prepared investors to identify immediately what the extent of the amount invested in a single operation is, and the leverage applied.

For many traders and investors used to the standard platforms this diversity can be a slight obstacle at the beginning. The important thing is to understand that the underlying calculations are always the same. We always talk of a broker that provides leverage and that obviously protects itself through the capital in your account.

If the capital is invested, or blocked as margin, the things are still the same.

 

Anyway, now that we know in detail how the CFDs of this broker work, let’s find out the section where we can see them in action. I.e. the Markets section of eToro.

 

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eToro CFDs for Social Trading: the characteristics ultima modifica: 2015-07-07T17:17:21+00:00 da Filippo

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