CFD Trading Vs Spread Betting

If you’re into investing, you’ll need to know about these financial instruments. Expert Michael Barton explains all on CFD trading vs spread betting, to give you some clarity on both.

Among modern financial instruments, CFD trading and spread betting offer unique paths to potential profits. Each also carries its own set of risks and individual features.

Bring tax into the mix as well, and the choice of which to use is anything but straightforward.

Pour yourself a cuppa, and prepare for a short read that answers your CFD trading vs spread betting questions.

What Are CFDs?

CFDs (Contracts for Differences) are financial instruments that let you speculate on asset price movements without buying or selling the underlying asset. (Yes, you can speculate on prices falling as well as rising.)

Essentially, you agree to either pay (make a loss) or receive (make a gain) the difference between an asset’s current price and its price when the contract settles.

The way that CFDs work means you benefit from leverage. Basically, you’re using other people’s money. That’s great when the price goes your way – you get more bang for your buck – but should the price move against you, the potential losses are also amplified.

The best way to show you this in action is to work through an example trade.

CFD Trading Example

Let’s say that you think XYZ shares are going to rise in value. Currently, the share price is £10.

Step 1: Opening The CFD Position

• You use 10:1 leverage and buy 1,000 CFDs on XYZ shares at £10.
• The total value of the position is £10,000 (1,000 x £10).
• Because you have used a 10:1 margin, you only need to deposit £1,000 to cover the position.

Step 2: The Price Moves

• As you predicted, the share price rises to, let’s say, £10.50.

Step 3: Closing The Position

• You decide to take your profits by closing the position.
• The closing value of the position is 1,000 (shares) x £10.50 = £10,500.

Step 4: Calculating Your Profit

• The profit you make is the difference between the value of your closing position and the value of your opening position.
• In this case, your profit is £10,500 – £10,000 = £500.
• Put another way, you’ve made a return of 50% on your £1,000 deposit!

CFD Trading Risks

Before you get carried away with that profit margin, you’ve got to be clear on the risk – and the risk is very real.

Let’s say that the company issued some unexpected bad news. So bad that the share price fell to £9. You position is now only worth £9,000… and you have lost your entire £1,000 deposit (which is called margin).

If the share price fell further, you could lose more than your margin.

CFD Trading Costs

The example above is very simplified to make it easy to understand. For example, I’ve ignored the costs associated with CFD trading. These might include:

Spread

This is the difference between the bid (sell price) and the offer (buy price).

What this means is that the asset price must move by the size of the spread for you to start to break even. The tighter the spread, the less the price needs to move for you to be in profit.

Commission / Trading Charges

Many CFD trades are commission free, but some brokers will charge a commission. Effectively this is a percentage of the trade’s value, or a fixed fee per trade.

Margin Calls

Okay, these aren’t really a cost, but they are certainly worth mentioning. If the price moves against you, your account could move below the required margin.

To keep your positions open, you’ll be required to deposit more money into your account (and that’s money you can’t use elsewhere or earn interest on elsewhere).

Holding Costs

If you hold a position overnight, you may incur a holding fee. Why? Because that leverage is really like borrowing money, and borrowing money costs money.

These costs depend upon two key factors – the direction of your trade (long or short) and overnight interest rates.

You may also be charged for market data feeds, platform fees, and inactivity charges.

What Is Spread Betting?

Like CFDs, spread betting is a derivative trading strategy that lets you speculate on the direction of an asset’s future price movement. Also, like CFD trading, you don’t buy or sell the underlying asset.

However, it works a little differently to CFD trading, insofar as you bet a certain amount per point of price movement.

Let’s look at how a spread bet might pan out:

Step 1: Placing The Bet

• You think the FTSE 100 will rise from its current level of 7,500.
• A spread betting firm are making a price of 7,495 (the bid price at which you can sell) to 7,505 (the offer price at which you can buy).
• You decide to go long, and buy the FTSE 100 at 7,505.
• You place a bet for £10 for every point that the FTSE 100 moves.

Step 2: Price Movement

• The market moves in your favour, and the FTSE 100 rises to 7,575 points.
• The new quote from the spread betting company is 7,570 to 7,580.

Step 3: Closing The Bet

• You decide to take your profit.
• You close the bet by selling £10 a point at 7,570.

Step 4: Calculating Profit

• Your profit is the difference between the price at which you opened the bet and the price at which you closed the bet x your stake placed ((7,570 – 7,505) x £10).
• The profit you make is therefore £650.

Spread Betting Risks

While potential profits are attractive, you must consider the risks.

If the price moves against you, your losses can mount up quickly – and the price of the asset must rise by the spread for your position to start to make a profit.

Spread Betting Costs

As well as the cost of the spread, spread betting may incur several other charges. Depending upon the spread betting firm you trade through, these might include:

Trading Charges

You may incur trading charges, especially if you place special orders like stop-loss limits.

Overnight Financing Charges

As with CFD trading, any open position held overnight could be subject to a holding cost, with the cost dependent on the direction of the trade, current market price of the asset, and overnight interest rates.

You may also be liable to margin calls to cover your bet exposure, platform fees, and inactivity fees.

Tax On CFD Trading V Spread Betting

CFD trading is considered an investment activity by HMRC. This means that any profits you make are liable to capital gains tax (CGT).

You’ll need to report profits and losses on your tax return, and then pay any applicable tax across all capital gains made during a tax year (though losses can be carried forward to offset against future CGT liability).

Conversely, spread betting is treated as gambling, which means that profits are not taxable. This makes spread betting particularly attractive.

Both spread bets and CFD trading are free from stamp duty.

(Note: Tax laws are subject to change, and this tax guidance is applicable to the UK at the time of writing – other countries may have different tax regulations.)

How Are Dividends Treated in CFD trading & Spread Betting?

When you trade in CFDs or place a spread bet, you don’t own the underlying asset. Therefore, you won’t receive any dividends the company pays.

However, the price of an asset is affected when a dividend is paid – it falls to reflect the value being taken from the asset.

For example, if a share is trading at £2.00 and it pays a dividend of £0.10 to shareholders, you should expect the share price to fall to £1.90 when the shares are considered to be trading ex-dividend (excluding the dividend).

To take the dividend effect into account, your CFD or spread betting trading account will be adjusted accordingly:

• On long positions, you will receive a payment to reflect the dividend on the ex-dividend date.
• On short positions, your account will be debited an amount equivalent to the dividend that holders would receive.

Remember, while your account may be adjusted to reflect the dividend, you don’t have shareholder rights or privileges. Adjustments for dividends are simply financial entries to ensure that no one is falsely advantaged or disadvantaged by a price movement caused by a dividend payment.

CFD Trading V Spread Betting V Investing In Shares

Trading in CFDs and spread betting are both derivative strategies that let you speculate on asset price movements without owning the underlying asset.

It’s easy to take advantage of rising and falling markets, and the ability to leverage your position makes it possible to take relatively large positions without large amounts of capital. The risk/reward profile is much more adventurous than trading in shares.

When you invest in shares, you are taking direct ownership of a share of a company. You can benefit from dividend payments and capital gain should the share price rise.

However, typically you won’t be able to take advantage of leverage – your gains are therefore much more limited when compared to the gains possible from CFD trading and spread betting.

Then again, so are any potential losses. It’s much easier to lose all your investment when you trade in CFDs or place spread bets.

In terms of taxation, dividends paid to shareholders and capital gains made are tax liable, though tax reliefs and allowances may cushion the blow.

Managing Risk In CFDs & Spread Betting

Understanding CFDs and spread betting, and the high risks associated with them, is the first step to taking advantage of the potential gains available.

Here are a few tips from my own experiences with CFDs and spread betting to help you protect your investment capital if you use these instruments in your investment strategy:

Never trade with more than you can afford to lose

And this means knowing the terms of leverage you are using and how price moves will affect your position.

Have a clear trading plan

Set your criteria for opening and closing positions, and stick to it.

Place stop loss orders

These will help to keep you disciplined if the markets go against you, and ensure any losses are manageable.

Raise your stop loss orders as market prices rise

If you have a long position, raise your stop loss orders as the price moves up.

This will help to protect your profits as the position moves in your favour. (Think vice versa for stop loss orders on short positions.)

Remain cautious with leverage

Your risk is directly related to your leverage, so err on the side of caution.

Practice with demo accounts

This will help you hone your trading skills and keep you grounded.

Don’t try & catch a falling knife

If you have a long position and it’s going sour on you, don’t keep on buying the further it falls.

Cut your losses & run your profits

Be quick to cut your losses and run your profits using increasing stop loss orders to protect you against sudden falls.

Be objective, not emotional when you trade

Keep your emotions in check, and stay level-headed, whether you are on a winning or losing streak.

My most pertinent piece of advice? If you want to use CFD trading and spread betting as part of your financial strategy, make it the speculative, more adventurous piece of the puzzle. It can be fun when you’re winning, but any losses can hurt like hell.

Get it right, and you will boost your portfolio value – but the key to long-term financial wellbeing is to accumulate sustainable wealth, as you would following a more traditional approach to investing.

How To Get Started Trading CFDs & Spread Betting

Trading in CFDs and spread betting can be exhilarating experiences. Whether you’re drawn to the flexibility and leverage of CFDs or the tax advantages and simplicity of spread betting, your first step is to open an account with a reputable CFD/spread betting firm.

You’ll need to do your research and sign up with a firm that aligns with your trading goals – and look for competitive spreads, educational resources, and user-friendly interfaces. A few platforms you might consider are:

• IG: Renowned for its comprehensive market access and powerful trading tools, IG offers a seamless experience for both CFD trading and spread betting.
• CMC Markets: Offering competitive spreads and a vast array of instruments, CMC Markets caters to both novice and experienced traders in CFDs and spread betting.
• Plus500: Known for its intuitive trading platform, Plus500 provides a straightforward trading experience, making it a good choice for beginners in CFDs.
• eToro: While famous for social trading, eToro also offers a robust platform for CFD trading.
• City Index: With a strong educational offering and advanced trading tools, City Index is designed to support traders at every step of their journey.
• Spreadex: Offering spread betting in both financial markets and sports betting.