A decision to invest in the financial markets can put you on the path to reaping some very enviable rewards. However, this does not always come easy for most of us, especially when there is a need to raise the necessary capital to gain significant returns. This is where leveraged products come into play. They offer investors a chance to earn significant exposure to the market with little initial deposit. Popular in the online space worldwide, spread betting and contracts for difference (CFDs) are fundamental leveraged products for the index, forex, and equity markets. Let’s run through two of the most popular trading possibilities to compare the two – CFD vs. spread betting – which one wins the battle?
Both are Leverage-Based Margined Products
CFD and spread betting trading are leverage-based margined products that provide benefits similar to investments in currencies, commodities, shares, and indices. They allow traders to speculate on a security’s price, all this without acquiring the underlying instrument.
This article explores the differences between CFD and spread betting trading and some important factors you need to consider when choosing between the two.
To build a surer journey towards successful trading, whether, in forex, indices, or stocks, it is important to understand the vehicles at your disposal to better speculate in these markets.
Contracts for Difference (CFDs)
These are derivative contracts between financial institutions and investors where the investor takes a position on an asset’s future value. The differences between the opening and closing trade prices are settled in cash.
No physical delivery of goods or securities happens with CFDs; rather, the contract itself has transferrable value within the period that it is in force. This means that a CFD is tradable security. This is established between the broker and the investor in exchange for the difference between the initial trade price and the value when the trade closes.
While CFDs allow investors to trade on future price movements, they cannot be regarded as futures contracts. They do not have pre-set prices for expirations dates but rather trade like any other securities based on buy and sell prices.
CFDs trade through a network of brokers over-the-counter (OTC) – they organize the market supply and demand and influence prices accordingly.
They are fairly simple securities calculated by the asset’s changes between entry and exit, with the price change only being computed separately from the asset’s underlying value.
Main Characteristics of CFDS
- CFD investors do not actually own the underlying asset. They instead receive revenue purely based on the recorded price change on the asset.
- They have the advantage of allowing investors access to the underlying asset at a dramatically lower cost than would be if they bought the asset outright. There is also added ability to go short or long as well as inherent ease of execution.
- There is, however, the disadvantage of an immediate decrease in one’s initial position based on the size of spread on entering the CFD.
- Weak industry regulation, need to maintain adequate margin and a possibility of lacking liquidity are additional downsides.
Like CFDs, spread betting allows an investor to place a wager on whether the market will fall or rise. The difference between the closing and opening trade prices are settled in cash.
It allows an investor to speculate, or rather, make a bet on whether market prices will rise or fall once their bets are accepted in an array of financial instruments – from commodities to forex and stocks to fixed income securities.
As would happen in sports betting, investors get to choose how much they would want to place as a wager with the bet not being transferrable to anyone else.
Branded as a commission-free, tax-free activity, spread betting allows traders to invest in both the bear and bull markets. Companies offering this service provide sell (for those who think the markets will tumble) and buy (for those who think the market will rise) prices.
As its name implies, it is indeed a form of betting, but not the fixed-odds type, since a specific event is not required to happen so that you can cash in. At any point, you can choose to close the bet and cash in on your profits or mitigate potential losses.
You also do have the option of getting into a long-term bet, as would be buying shares or a short-term one, synonymous with selling a share based on your preference and market movements.
The Main Differences – CFD vs. Spread Betting
in relation to CFD vs. Spread Betting we have listed some of the biggest differences here:
|Spread Betting||Contracts for Difference (CFDs)|
|1||Fixed expiration dates||No fixed expiration dates|
|2||Done over-the-counter (OTC) through a broker||Can be completed directly within the market i.e., direct market access (DMA) that allows transparency and simplicity|
|3||Spread betting companies do not charge commissions or fees||The investor pays commission charges and transaction fees|
|4||Tax free||No stamp duty, but you pay capital gains tax|
|5||Can’t offset losses against tax||Can offset losses against tax (ideal for hedging)|
|ii||Trade on leverage|
|iii||Go short or go long (good for hedging)|
Once the contract closes, you are either owned or owing money to the trading company. When profits are made for the CFD trader, their net profit is the difference between the closing and opening trading value fewer fees.
For spread bets, profits are calculated by multiplying the change in basis points by the negotiated dollar amount agreed-upon when placing the initial bet.
Regulation In Various Countries
Another aspect of CFD vs. spread betting is, of course, where it is permitted to trade CFDs and where you can spread bet?
In Britain and many parts of Europe, spread betting is legal but with disparities in how gains are taxed from country to country.
In the United States, Japan, and Australia, spread betting is illegal. However, many investment brokers and banks offer derivative products that, in many ways, mimic spread bets.
Spread betting is broadly illegal in China, though it is allowed in special administrative zones, including Macau and Hong Kong.
Contracts for difference (CFDs) are available in several markets, including the United Kingdom, Germany, Switzerland, Singapore, Australia, Spain, France, South Africa, Canada, New Zealand, Hong Kong, Sweden, Norway, Italy, Thailand, Belgium, Denmark, and the Netherlands.
CFDs are not permitted in the United States due to the Securities and Exchange Commission’s restrictions on over-the-counter financial instruments. However, non-residents can use them.
CFD vs. Spread Betting – Wrapping Up
Let us wrap up our explanation of the differences between CFD vs. spread betting. These near-similar modes of the online investment offer attractive options to traders. The subtle differences between them may understandably evade the rookie investor. CFD advantages include easy access to global markets, lower margin requirements, and no shorting or day trading rules.
Spread betting, on the other hand, has been credited for lowering barriers to entry, and with low capital investment necessary, plus the availability of risk management tools as well as tax benefits, it is a compelling option for speculators
Nevertheless, with both options, your capital is at risk. You will need to analyze what investments can carefully guarantee maximum profits; this will come with education and practice.