Both spread betting and CFD trading are forms of derivatives.
This means traders speculate on the price movements of underlying assets, but do not own these assets themselves.
Despite this similarity, the two types of trading differ in their structure, taxation, and regional availability.
What is Spread Betting?
Spread betting is betting on which way the spread or price of a financial asset will move.
Instead of buying shares or commodities, traders speculate on whether the price will rise or fall based on the spread quoted by a broker.
When placing a spread bet, the trader decides on a stake size. This is the amount of capital wagered on each point of movement.
If the trader is correct with their bet, the profit is calculated by multiplying the original stake size by the number of points the market has moved.
If the trader is incorrect, and the price moves the other way, they make a loss. This loss is calculated in the same way – the number of points moved, multiplied by the stake size.
For example, a trader buys an instrument with a quoted price of 102, and chooses to stake £10 per point. If the price jumps to 130, the profits are calculated like this:
(130 – 102) x £10 = £280 profit.
But if the price instead falls to 100, the loss is calculated like this.
(100 – 102) x £10 = -£20 loss.
What is CFD Trading?
Trading CFDs (Contract for Difference) involves making an agreement with a broker to speculate on price movements of various assets, e.g., stocks, without owning the underlying asset.
These contracts mirror the price movements of the underlying assets and never expire.
If the trader is correct in their prediction, they make a profit. If they are wrong, they make a loss.
The size of the profit or loss depends on the pips. For most pairs, a pip is a movement at the fourth decimal place – 0.0001.
However, for pairs with the Japanese Yen as the quote currency, a pip will be a movement at the second decimal place – 0.01.
The value of each pip movement is calculated as follows:
(0.0001 / the currency pair’s exchange rate) x the lot size
(Note: This 0.0001 represents one pip on most currency pairs, but traders will need to substitute in 0.01 for pairs with the Japanese Yen as the quote currency.)
So, if one unit of the base currency is worth 0.901811 of the quote currency, and the trader is using standard lots, this is the calculation:
(0.0001 / 0.901811) x 100,000 = 11.088798
In this example, each pip is worth 11.088798 units of the base currency.
Profit or loss is calculated by multiplying the total pips moved by the value of one pip.
How do Spread Betting and CFD Trading differ?
While both spread betting and CFD trading are derivative products that allow for leverage or margin trading and permit shorting, there are differences between the two.
Firstly, with spread betting, the trader places a stake or bet per point of movement of the underlying instrument.
Profits and losses will depend on how many points the market moves, multiplied by the stake.
When trading CFDs, traders buy a contract that represents a measurable market value of the actual instrument traded.
Any profits or losses are calculated according to the difference between the opening and closing prices for each lot in the position.
Secondly, spread betting is mostly only available in the UK and Ireland, while CFD trading is permitted in many countries.
Thirdly, taxes are applied differently for each derivative. The Financial Conduct Authority (FCA) considers spread betting a form of gambling. So there is no capital gains tax or stamp duty applied to spread bets, and losses can’t be offset against tax.
The FCA, however, considers CFD trading a form of investment. This means any profits are taxed, but it also means traders can declare losses on their tax return.
Other differences relate to expiry dates. A spread bet always has an expiration date, while CFDs do not.
Spread betting is also always conducted in GBP, unlike CFDs, which are usually executed in USD, meaning that traders may incur currency conversion costs.
Which One is Right for You?
CFD trading and spread betting are both leveraged ways to trade the financial markets.
While this can help to maximise any potential profits, it can also amplify potential losses.
Losses can exceed deposits, which would leave the trader with a negative balance. Risk management strategies offer some protection against this, for example, by applying stop-loss orders before the contract is initiated.
Traders who can access both spread betting and CFDs in their jurisdiction will consider their goals, risk tolerance, and trading cost considerations before they make their choice.
Many short-term traders, like day traders, choose spread betting. This is because of the simplified cost structure – there are no commissions, and the cost is built into the spread.
To start placing spread bets, traders first choose a spread betting platform that suits them. Most traders choose brokers and platforms regulated by the FCA, as this provides an element of protection.
Spread betting traders also look for a broad range of markets, which helps them diversify their strategies, and positive reviews for customer support.
Traders outside of the UK and Ireland will need to choose CFD trading instead, as spread betting is not available in most other jurisdictions.
Some traders actively prefer CFD trading for its wider range of markets and more advanced trading features.
These traders may choose to execute either short-term or long-term CFD trading strategies and use CFD trading’s potential for portfolio diversification and hedging.
