The difference between spread betting and CFD trading can be confusing. And it’s further exacerbated by CFD and spread betting brokers using complicated jargon.
This article will explain the difference between spread betting and CFD trading in simple terms that are easy to understand regardless of your experience.
We’ll cover exactly what spread betting and CFD trading are and the various advantages and disadvantages of spread betting vs CFD trading.
Firstly, I’ll give you a quick overview of spread betting and CFD trading and what the main differences are.
Spread betting vs CFD trading
The main difference between spread betting and CFD trading is how they are treated for Capital Gains Tax (CGT). Spread betting is free from Capital Gains Tax whereas CFD trading profits are taxable for CGT. Spread betting is only available in the UK and CFDs are available to trade worldwide.
Both spread betting and CFDs enable traders to go open long and short positions. Both spread betting and CFDs mimic the respective underlying asset too, although there is a difference in how they work including the tax treatment…
- Spread betting allows traders to bet an amount of money per point of price movement in the spread bet’s underlying asset
- CFD trading is a contract for difference between the price at which the CFD trade was opened to when the CFD trade is closed
One final difference between spread betting and CFDs is that traders can trade with direct market access (DMA) on CFDs. We will cover this later in the article…
Spread betting explained
When trading financial markets with spread betting, you are speculating on whether the market price will go up or down. You bet using the spread per price movement.
For example, let’s say we open a spread bet trade on Vodafone at £100. Our spread bet trade would increase or decrease by £100 per point movement.
For an in-depth walkthrough of spread betting, you can read my guide on exactly what is spread betting.
Advantages of spread betting
There are several advantages of financial spread betting. The main benefit for spread bet trading and one of the key differences from CFDs is that all gains are free from Capital Gains Tax and stamp duty.
Here are further advantages of spread betting:
- No commission with spread betting as we only pay the spread on trades
- Spread betting allows us to trade a variety of markets
- Trading with spread bets enables us to bet on prices rising and falling
- Spread betting gives us leverage meaning our capital works harder
- We can trade with rolling daily funded bets or contracts that have an expiry date
Learn how to leverage the advantages of spread betting to your advantage with my exclusive spread betting tips and strategies.
Disadvantages of spread betting
The only disadvantage of spread betting compared to CFD trading is that we cannot trade with direct market access. This means we aren’t able to place trades directly onto the orderbook.
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CFD trading explained
Trading with CFDs is similar to spread betting in several ways. Both spread bets and CFDs are also leveraged and so we can make our capital work harder. CFDs work by mimicking another financial instrument, and therefore is a derivative product.
With CFDs, our trade size is measured in the number of contracts multiplied by the price on the contract. When we close a CFD trade our profit or loss is the difference between the opening price of the contract and the closing price of the contract multiplied by the number of contracts.
CFD traders should take note that when dealing in stocks there is no expiry date, and that there are also commission charges unlike spread betting.
Advantages of trading CFDs
The main advantage of trading with CFDs is that we have direct market access on the orderbook. This means we can get better prices as we are dealing inside the spread and we are able to become a market maker.
Here are further advantages of trading with CFDs:
- Trading with CFDs is leveraged meaning our capital works harder
- CFDs allow us to trade a variety of markets
- We can trade both long and short with CFDs on rising and falling markets
- There is no stamp duty when trading with CFDs
- We can offset losses against profits on CFDs for tax purposes
Disadvantages of trading CFDs
The main disadvantage of trading with CFDs is that they are not exempt from Capital Gains Tax unlike spread betting.
What is leverage?
Leverage is a magnifier and it means that we can take positions that are worth more than the capital that we have on deposit.
For example, a mortgage is a form of leverage. If you have a 10% deposit and are granted permission to buy a house then that means your capital is 10x levered. You have bought an asset that doesn’t require the full 100% of capital to be put down.
You can also do this when buying a car. This is leverage in the form of debt financing.
When trading stocks with leverage, the spread bet broker grants us the power to use a multiplier effect on our capital.
For retail investor accounts (you are automatically a retail client in the UK unless you sign a form to certify yourself as a professional) you will have access to margin of 5:1. This means that you can leverage your capital five times.
To use an example, if you have £10,000 in your spread betting account then you will be able to trade a position of up to £50,000.
This means that if the position were to rise 10% to £55,000, then the £5,000 would be your profit and your return on capital would be 50% (£5,000 / £10,000 = 50%).
However, leverage works both ways. If the position were to drop 20% and move to £40,000, your entire capital of £10,000 would be lost. As the margin used 5:1 then a 20% move equates to a 100% gain or loss.
Leverage can be a powerful tool in making our capital work harder for us but you should be careful not to abuse it. Far too many traders end up in the poorhouse because they couldn’t handle their leverage. You should consider leverage high risk and your own individual circumstances, and exercise caution when trading complex instruments such as spread bets and CFDs.
What is Direct Market Access?
Direct Market Access (DMA) is the ability to place traders directly onto the stock exchange’s order book (t can also be used for forex). Using Level 2 data we can see the full order book of buys and sells and the market as it is.
One benefit of direct market access is that we become the market maker and we are able to set specific prices and sizes in order to deal in the market.
Spread betting or CFD: Which is best for you?
Both spread betting and CFD trading are leveraged products and so caution must be exercised.
However, spread betting and CFD trading can be beneficial for our trading arsenals when used correctly and appropriately.
Below is a comparison of both spread betting and CFD trading…
Reasons spread betting could be a better option for you:
- You want your trading profits to be tax-free
- You don’t want to pay any commission on trades
- You want to trade across a variety of markets in pound sterling
- You want to make your capital work harder for you
Reasons CFD trading could be a better option for you:
- You want greater trade versatility when placing orders with direct market access
- You’re comfortable with the underlying market and want to trade with leverage
- You want to offset losses against profits
Remember, always ensure whether you are spread betting or CFD trading that you use a broker regulated by the Financial Conduct Authority (FCA). This is because your money is important and signing up with a spread betting provider or CFD provider that isn’t regulated by the FCA may not be able to protect you should the broker.
Spread bet and CFD traders can see benefits to their trading account but should have strong trading risk management controls.
Trading strong market moves with leverage must come with a risk warning, and you should always understand the trading platform by using the demo account before moving to a live account. I have seen many traders blow their trading accounts before of short-term market moves that went against them.
Risk warning: If you are new to the stock market or want to start trading, then financial derivatives should be used only when are you consistently profitable when trading stocks.