There are a number of people who consider CFD trading to be just another form of spread betting. However, while there may be similarities, they are actually quite different. Both are a very popular form of investment and youâ€™ll find a number of the top rated CFD brokers offer spread betting as another option. For the average man or woman on the street, both CFD and spread betting offer the potential for significant gains, with very little capital requirement. However, both also have the potential to be very costly if you donâ€™t trade them in the right way. Before we look at how these two forms of investment are different letâ€™s consider the similarities.
How CFD and spread trading are the same
Whether you are CFD trader or spread better you will be presented with bid and offer prices and have the opportunity to go long or short. You also have the chance to make money whether the markets are rising or falling. Both types of trading do not require you to physically acquire an instrument but are instead speculate whether the price will move up or down. Another similarity is they can both be traded on margin. This means you can open an underlying position of a much higher value than your actual funds. For example, establishing a $200,000 position with a 10% margin rate will only require a deposit of $20,000.
What are the benefits of spread betting?
- No capital gains tax payable in the UK
- Generally, there is no commission – Brokers tend to make their money through the spread
- It is easier to bet in the currency of your choice, thereby providing greater control of currency exposure
- Deals can be made in both rising and falling markets
- Leverage is available
- No stamp duty payable in the UK
- Dealing is possible 24 hours a day
- Prices used are based on the underlying markets
What are the benefits of CFDs?
- For Forex and shares, there is generally direct market access
- Market prices are given for trades on shares
- It is possible to offset losses against profits for tax purposes
- It is possible to trade on both rising and falling markets
- Leverage is provided
- Stamp duty is not paid
- Dealing takes place around the clock
- Prices are based on the underlying market
Worried about paying tax and charges? CFD and spread betting compared
For more than a decade, professionals at various banks and hedge funds have been using CFDs. More recently, they have become very popular for the Average Joe, particularly in places where spread betting is not permitted such as Australia, South Africa, Europe, and the Middle East. In the UK, there are a number of tax advantages with both forms of trading. Spread betting and CFDs traded by UK residents are not liable to stamp duty. This is because a trader never actually owns the underlying instrument. CFDs are liable for capital gains tax in the UK, whereas spread betting is completely tax-free. Tax is possibly one of the biggest reasons traders are choosing spread betting over CFD trading. Profits made from CFD trading are taxable, whereas those made from spread betting are not. However, there is another significant difference in terms of tax. CFDs attract tax relief on losses but spread betting doesnâ€™t. Charges in CFD and spread betting are also significantly different. A broker offering spread betting as an option will take a cut via the bid/offer spread. CFD brokers, on the other hand, tend to add an additional fee on top of the spread. This is because CFDs are similar to borrowing an asset in order to bet it will rise in price. Your broker has lent you the asset so is bound to expect to earn money for such a service. So is one better than the other? If youâ€™re a beginner you may well find spread betting a little easier, as the charges are easier to understand as is the tax situation. Indeed, many Forex traders prefer it because it works out to be the cheapest option. CFD traders tend to be more experienced and more inclined to be looking for long-term trading opportunities, and also seem to be more patient.
The differences between CFDs and spread betting in more detail
Contract periods and trading times Both spread betting and CFD products are traded on margin, which means there will be a cost involved. Spread betting brokers build their costs into the spread and rollover charge. Whereas for contracts for difference, there is a daily funding charge for long positions held overnight. Positions opened and closed in the same day, however, incur no interest charge. While short positions are liable to an interest rebate. There is no expiry date for a CFD and no funding charge for positions which are opened and closed the same day. Spread betting positions have an expiry date and similar to futures products. The position can remain open for a specified period of time. Whether that is one day, a week, a month or quarterly. When the position expires it is automatically closed or rolled over, according to the requirements of the trader. This doesnâ€™t happen with CFD trading. There is a premium already built-in to a spread bet, which is similar to a futures contract. A futures contract has a â€˜fairâ€™ value which is based on funding charge that lasts until expiry and any dividends are paid. The financing charges for CFDs are applied separately, which can lead to a tighter spread. This will suit some traders but not others.
Tax advantages If you want to spread bet or trade CFDs youâ€™ll be pleased to learn you will not incur stamp duty. CFDs, however, are liable to capital gains tax at your marginal tax rate, after youâ€™ve reached your annual allowance. Spread bet profits, on the other hand, are completely tax-free. However, there is a downside, in that losses you might incur through spread betting are never recoverable, but CFD losses can be offset against future earnings for tax purposes. This can have a psychological effect in that youâ€™ll be comfortable paying capital gains tax if youâ€™re already winning. But if you are losing at spread betting you are already paying a wider spread, as well as losing money.
The cost of trading and price transparency The fact that spread betting is completely tax-free may lead you to wonder why anyone would choose CFD trading. The reason lies in the prices, especially if you are trading CFDs in conjunction with direct market access. Trading costs are usually represented in the bid/offer spread for both spread bets and CFDs. The difference lies in the fact that most CFD brokers let you post orders within the spread. Therefore, you become a price-maker, rather than a price-taker. Traders placing large CFD orders are also able to improve on the available marketplace bid/offer spread. The biggest cost when trading is the bid/offer spread and the differences between CFDs and spread betting is why many professionals choose CFDs. Being able to access live market prices also means you are getting access to real prices and the best liquidity, giving you more protection when the market moves aggressively against you. Choosing to spread bet means you are always trading slightly behind the market, often with a wider spread. The fact you have a contract with a market maker is also a disadvantage as they may quote a price more advantageous to themselves rather than you.
How trades are placed This is another aspect in which the two types of investment are different. When you spread bet you are betting a certain amount of money per point on any given market. CFD trading, on the other hand, involves trading a certain number of shares or lots, much like traditional share trading. A spread bet will have a premium built into the price and will usually be above the underlying share price. Any corporate action that takes place will generally apply to both types of investment, except in the case of dividends. The holder of a CFD will receive a credit of the net dividend, whereas with spread bets the anticipated dividend is already built into the initial price.
Conflict of interest and counterparty The relationship between a provider and its client is very different. A broker who offers spread betting is little more than a bookmaker. As a client, you will be no more than a price taker of whatever two-way price is offered. There is no way you will be able to influence the price or be able to deal at a better price than the one offered. A spread betting provider makes its own prices, based on the actual market price. It will sell at the highest price it is able to get and buy at the lowest. There is no incentive for the spread betting provider to make this any better. A spread betting broker may be obliged to offer the best execution prices but there is still a conflict of interest. CFD trading with direct market access is completely different and more like a traditional stockbroker, in that the CFD broker is acting as an agent. The CFD broker may be counterparty to a CFD transaction and hedging in the cash market, but any improvement in the price will be passed on to you, the client, as there is no spread which needs to be added on. CFD trading allows you to use DMA to post your orders within the bid/offer spread. Thereby giving you access to the greater liquidity available in the main market and enabling you to be a price maker as opposed to a price taker. A CFD broker earns commission on the trade and makes a charge for any borrowed funds. A CFD broker also offers much more in the way of service than simply opening and closing trades. You may receive reports and research, commentary, and opinions, and be able to relay messages, stories and listen to market gossip.
Recommended CFD Brokers
Spread betting or CFDs? Which one should you choose?
Spread betting may be a better option if you want…
- your profits to be tax-free
- control over the size of your deals
- to be able to be able to deal in smaller sizes and not have to pay any penalty in the form of a minimum commission
- to have access to all international markets in the currency of your choice
- to take more of a long-term view on shares and Forex with forward markets
CFD trading may well be a better option if you want…
- a product that feels similar because youâ€™re already very comfortable with the underlying market and terminology
- to get the benefits of over the counter trading and use DMA for shares and Forex trading
- to offset your losses against profits as a tax deduction
- to open a professional or corporate trading account
- to be able to efficiently hedge with the help of the tax-deductible benefits of CFD trading
- to hedge physical assets in your portfolio
Basically, a spread bet is a way of investing that allows you to speculate on financial markets. You arenâ€™t trading the markets, but are betting on an outcome based on underlying data. Spread bets have a fixed expiry date. CFDs, on the other hand, are a financial derivative and you are trading a contract based on prices derived from the underlying market. When you trade CFDs with Direct Market Access you are allowing your broker to place a parallel trade in the market. CFDs do not have an expiry date unless they are futures, options, or binaries. So there you have it. The difference and similarities of CFD trading and spread betting. Which one should you choose? That is a decision only you can make, based on your requirements and needs. Weâ€™ve given you all the pertinent details so you are now in the best position to decide.