The key differences between spread betting and CFDs
13th Nov 2022 Investment
5 min read
The key differences between spread betting and CFDs
Whether you decide to trade commodities, Forex, stocks, or anything else, there is some worthwhile profit potential, as well as a host of risks that could see you losing out. Many traders find that their own collateral just isn’t enough to take up the positions they’d like and when this is the case, leveraged trading with spread betting or CFDs (contracts for difference) could be the solution.
What is leveraged trading?
Leveraged trading is often utilised by traders to increase the funds they have on hand to make more lucrative trades. They will apply to brokerages who will allow them to trade with additional collateral with the aim of benefiting from their endeavours. As traders will only need to put forward a small percentage of the full value of the trade, the initial outlay is more affordable.
Most leveraging happens using derivative products like spread betting and CFDs (click here to find out more), and those interested in these types of trades may want to select one as their preferred vehicle.
Spread betting and CFDs
As these are both derivative trading products (where value is derived from underlying assets), it may be difficult to make a selection. The good news is that these are worthwhile alternatives to direct investments and there are differences that can help with your decision. In the simplest terms, trades are made based on whether a market will rise or fall in spread betting, whereas CFDs work with the price movements in specific assets instead. Derivatives allow traders to partake in both long and short positions. Brokers in the industry are also protected by the FCA, who act as industry regulators.
The differences
- Spread betting functions via over-the-counter transactions (OTCs) that are completed by the broker and trades will have expiration dates. As CFDs are typically traded directly on the market, these are not subject to the same restrictions (traders can opt to use a broker for advice, access to trading insights and to make use of tools).
- Fee structures also differ, spread betting will see the trader either being paid or paying out (depending on the success/failure of trades), yet CFDs will have traditional trading commissions and fees.
- Profits for spread betting are worked out via the difference in points and multiplied by the GBP agreed when the bet was placed. In the case of CFDs, profits can be enjoyed at the closing position, once the opening position cost and any applicable fees have been covered.
Pros and cons of spread betting
The pros of spread betting are:
- You will have access to highly qualified, experienced brokers
- There’s no stamp duty to be paid
- All profits are tax-free (free from Capital Gains Tax)
- No commission
- Small percentages on trade values
- Negative balance protection
The cons of spread betting are:
- As trades are leveraged, losses can exceed the initial deposit
- Slightly less flexible uses for winnings than with CFDs
- There are financing charges (typically known as holding fees) applicable to rolling daily positions that occur overnight
Pros and cons of CFDs
The pros of CFDs are:
- You will have access to highly qualified, experienced brokers
- There’s no stamp duty to be paid
- Small initial deposits
- Small percentages on trade values
- Competitive spreads
- CFDs are available in many countries around the world
The cons of CFDs are:
- As trades are leveraged, losses can exceed the initial deposit
- Financing costs, holding costs and fees may impact long term trading endeavours
- Trading CFDs requires a time commitment
- CFDs are subject to Capital Gains Tax
- There are no real shares (you can never co-own the company you trade on)
The Risks
Leveraged trading involves risk, therefore it’s important to mitigate this on your trading journey. For example, many platforms offer the chance to trade through a demo account first. Furthermore, it’s essential to research the markets you’re looking to trade in before placing any trades. Once you’re ready to make use of a live trading account, make use of mechanisms such as stop losses for extra protection from potential losses.
The Bottom Line
As both spread betting and CFDs are derivative trading products they have many similarities, but a host of individuals tend to overlook the key differences that could impact the way that they trade. Both have their risks and benefits, so when deciding which one to use, it can be important to understand your own needs first. Keep in mind your commitment, budget, trading style and work out how much costs like taxation and fees may impact your projected gains. Research will be your best asset, so be sure to look into brokers, trading platforms, tools and more to minimise risks and enhance your ability to trade at a profit.
Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. The vast majority of retail client accounts lose money when spread betting and/or trading CFDs. You should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money.
Tax treatment depends on your individual circumstances. Tax law can change or may differ in a jurisdiction other than the UK.
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