The choice of ways of trading the markets has never been so wide. Here’s why you might choose spread betting (spread trading) or CFDs over the others.
CFDs and Spread bets are very similar – but not identical – trading products. So, why might you choose to play the markets with one instead of the other? And why would you choose either of them rather than one of the ever increasing number of alternatives?
Here are some of the key similarities and differences between spread bets, CFDs and other derivative instruments.
In common with most derivative instruments, spread bets and CFDs are geared products. Gearing means a small move in the market you’re trading becomes a much bigger move in the return you make. Spread betting and CFDs’ gearing comes from borrowed money: the fi rms that offer them only require you to put up a fraction of the total value of your trade as a deposit. They provide the rest.
Big Gains, Big Losses
Because spread betting and CFD providers only require you to put down a small deposit in relation to the total value of what you’re trading, you can make big losses unless you’re careful. Your maximum loss is not known in advance. Say you are trading to exploit an expected fall in a particular company’s share from its current level of 100p. The company then gets a takeover bid out of the blue at 200p. You are thus left with a huge and unforeseen loss.
Not knowing what your potential losses are in advance is a feature of spread betting and CFDs, as well as certain option-selling strategies and futures contracts. By contrast, your maximum liability is known right from day one if you are trading fi xed-odds or binary bets, as well as covered warrants or if you are buying traded options. You can never lose more than your starting stake with these products.
Profits from spread bets are not taxable for UK tax-residents. While contracts for-difference (CFDs) work in virtually the same way as spread bets, capital gains tax is potentially payable on any profits.
Spread betting is not the only form of tax-free trading, however. Fixed-odds and binary fi nancial betting is also classified as gambling and therefore any winnings generated are not subject to tax.
Just as spread betting profi ts aren’t subject to tax, neither can losses be written off against your capital gains elsewhere. Being able to off set trading losses against gains you may have made on your shares, property deals or other transactions can be attractive for certain traders, particularly more heavy ones.
Markets you can Trade
You can bet on an impressive array of financial markets through spread bets. The range is similar to what you can trade with CFDs, although there may be more choice of individual shares that are accessible via CFDs. Spread betting’s range of markets compares favourably to that on offer via fixed odds betting, covered warrants, and many other geared structured products. Many of these other methods only provide access to a handful of underlying markets.
Best Suited for Short Term Trading
Although it is possible to use spread bets to take longer-term positions, they are best suited to speculation over shorter periods. This makes them similar to CFDs and to fixed-odds financial bets. With both spreads and CFDs, a daily financing charge applies to “buy” trades. This can really add up over time, so the market you are trading needs to move in your favour to offset this cost.
If you want leveraged exposure to a market over several years, one way to achieve this would be to buy an accelerated tracker or geared ETF. These products will give you a multiple of the return that the underlying market provides, without an ongoing finance charge.
As well as paying a daily financing charge on a long CFD position, CFD trades on shares – but not on indices, bonds or currencies may attract commission. The typical charge on a CFD deal is 0.10% of your position’s total value both when you open and close the trade (may be subject to a minimum fee of, say, £10 – although this varies from provider to provider). There is no commission to pay on spread bets on any product, by contrast. This is included in the spread.
If sterling is your home currency, there is no currency risk with a spread bet. Whatever the instrument you are betting on – be it the Brazilian stock market or the Japanese Yen/Swiss Franc exchange rate – your bet will be quoted in pounds, as will all your profits or losses. Some spread betting firms may allow you to deal in US dollars or Euros if that’s what you want to do. CFD positions, by contrast, are generally quoted in the currency of the asset you are trading. So, if you are buying a crude oil CFD, your position will be valued in dollars. This creates the risk that a falling dollar will reduce your profits or intensify your losses. Fixed-odds and binary bets are like spread bets, in that they are quoted in sterling (or perhaps another currency selected by the trader).