The natural gas experiment - the analysis

It sounded so easy - too easy. Making money by opening buy and sell trades at the same time without the risk of loosing money. I liked the idea, so I did some calculations (that I presented in this older post) and figured: This can actually work. So far it was only a theory. In order to find out if it really works, I started an experiment and opened a buy and a sell trade for $NATGAS at the same time. Just two days later the experiment was finished, when the sell trade hit the stop loss. Unfortunately the trading strategy didn't work. In this post you can find my analysis, why the theory was wrong.


Let's first have a look at the numbers of my trades, when they were closed:

sell trade: -50,33%
buy trade: +43,33%
overall: -3,5%

Whenever I checked the status of the trades while they were running, the overall loss was always -3.5% (which is the spread for both trades). First I wanted to know whether the asset movement was simply to too small and the profit gained by the strategy was erased by rounding errors. So I took the calculation I made prior to my experiment and calculated the profit with the exact numbers of my trades. According to this calculation the overall loss was down to -2,1%. Due to the spread it is still negative but there is already 1,4% gain. It is clear that my calculation doesn't behave like my eToro account. I started some more calculation and did some research just to find out, that I hadn't understood the principle of CFD-trading. Here is how I now understand how profits and losses are calculated:

When I buy natural gas on eToro, I don't really buy gas (I was clear about that). What I buy is more or less a lottery ticket. If the asset is moving in the direction I predicted, I win. If it moves in the other direction, I lose (still clear so far). When I "bet" on gas I buy one or more number of units, that are kind of shares of the asset. What I was not aware of: The price for one unit is not necessarily the same as the price for the asset. Profits and losses are not calculated on the basis of the opening rate of the trade, but on the basis of the unit price. Let me explain that further on the example of my $NATGAS buy trade:

I invested $100 in gas, at a rate of $3,342. The unit price was $3,000 though, so for $100 I would have bought 33,333 units of $NATGAS. Due to the leverage of ten that I used, I actually bought 333,33 units. Every pip that the rate of $NATGAS increased was equal to $0,33 of profit. The trade was closed at $3,472, a total of 130 pips. That is a profit of 130 x $0,33 = $43,33 (+43,3%) - exactly the amount I gained on eToro. However, if I calculate the relative increase of the asset price, my profit had only been 38,9%. You can find more details in the table below:



With that new knowledge it quickly comes clear, why the strategy (buy and sell at the same time) is not working: The value of one pip (=$0,001 in rate) is defined by the unit price, the leverage and the trade size. It can be calculated as follows:

pip value = (trade size x leverage)/(unit price in pips)

In my case the formula fills ab this way:

pip value = ($100 x 10)/($0,001) = $0,33

So for every pip the price of gas moved up, I made a profit of $0,33 - and that value is not depending on the price of the asset at the time the trade is opened! The same is pip value appears for an according sell trade - and that is the key to the strategies failure. When gas moved up one pip, I gained $0,33 on my buy trade but lost $0,33 on my sell trade at the same time. The difference between both trades was always the spread.

Beside the fact that the strategy is not working, I found another interesting point: The height of profit or loss on CFD-trading is not only depending on the market movement, but also on the difference between asset price and unit price. In the above shown example, the asset price was higher than the unit price. Therefore my profit was higher, than the relative increase of the asset price. For the sell trade it was the other way round: The loss was higher, than the relative increase of the asset price. If the unit price is higher than the asset price, the behavior is vice versa.

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Check out the beginning of the natural gas experiment: Follow this link to my older post

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Important remark: The results presented above and throughout my blog are no recommendation for your trading! I only share my personal findings and opinions to give ideas and let my followers and copiers know what I am currently working on. I can not guarantee the correctness of my calculations and my presented results. Furthermore past performance is not an indication for future results. Only trade with money you are prepared to lose!