What is the Difference Between CFDs and Spread Betting?
Spread Bet vs Contracts For Difference: Overview
If you live in the United Kingdom or Ireland and are new to trading then the chances are that you will at some point end up spread betting, or at least considering it.
If you don’t live in the UK or Ireland then you can move along, as spread betting is not legal in your country!
The big-picture difference is that spread betting is classified by the government as gambling rather than trading. This has a host of implications, the biggest of which is tax. More on that later.
The second principle difference is that, although the two products are traded in a similar fashion, the underlying mechanics and pricing are slightly different.
Gambling vs Trading
In the UK there is no tax to pay on gambling winnings. If you win the lottery in the UK you get to keep it all. Compare that to the USA where you have to pony up a massive chunk of your new millions to the US Treasury.
Since the government classifies spread betting as gambling, that means that there is no tax to pay on your profits. It is exactly the same as if you went into a betting shop and picked the
Grand National winner – you don’t have to ring HMRC and tell them you are now £10 richer.
The same applies if you win £10 on a spread betting trade (or indeed, ‘bet’).
The Government classify CFDs as trading not gambling, so if you win you should pay Capital Gains Tax (CGT) on your profits. The exact rates and amounts you pay will depend on individual circumstances.
You do not have to pay stamp duty like you do with standard share dealing, however.
So, difference number 1 – No Tax to Pay on Spread Betting Winnings
BUT, there is a counterpoint. In the same way that you don’t pay tax on spread betting winnings, you also don’t get to offset your losses in your tax. If you lose in CFD trading you can offset your CGT against profits you may make in other areas of your investments or other income.
This also means that CFDs can be better for hedging. If you are trading a strategy that means you may actually be hoping for a loss on some of your trades, then your ‘hedge’ trades would be better off in CFDs as you can then offset those losses against your wider tax.
Obviously we are not tax experts – do your own research or speak to an accountant!
The Mechanics of Trading
The most apparent difference to the user between CFDs and Spread Betting is the basic mechanics of how you place and price a trade.
In spread betting it is extremely simple. Say you think GBP/USD is going up by 50 pips then place a Buy order and choose the pip amount. So if you choose £1 per pip then if it goes up 50 pips you make £50. If you choose £10 a pip, when it goes up you make £500.
Obviously if it goes against you then you lose £1 a pip or £10 a pip or whatever you chose to bet.
If you bet £1 a pip with a 50 pip take profit and a 25 pip stop loss on CMC Markets, then your order ticket will look something like this:
What is the Difference Between CFDs and Spread Betting ? – Image 1
With CFDs it is a little more complex. Each product you look to trade has a price per unit set by the broker. This isn’t necessarily the ‘number of the thing’ you are buying. What I mean is that if the UK 100 is trading at 6828 then the contract price may in fact be a different number altogether. Or so it may seem. This is often due to currency differences.
So, for instance, at the time of writing on eToro the UK 100 Index contract price is $8500 and on CMC Markets it is £6828. Right now, that is the same monetary value, but for the uninitiated it can seem a bit unclear.
The good news is that you can trade on leverage (more on this later) so you don’t need to allocate the full £6828 to trade on contract.
For instance if you trade on 100x – so you can allocate £68.00 to this trade from your account balance and still control 1 contract. As I say, more on leverage below.
As the price moves then you multiply the points gained or lost by the number of units you bought.
Say you Buy GBP/USD and you want the same trade as in our spread betting example. A common leverage requirement on CFDs is 500x.
So if you want to buy GBP/USD at 1.23987 and you put a 50 pip take profit and a 25 pip stop loss then your order ticket would look something like this:
What is the Difference Between CFDs and Spread Betting ? – Image 2
Note that the £40.45 take profit amount is calculated using the quote currency of 1.23987 rather than the base GBP. That is why it doesn’t show a £1 per pip equivalent of £50. In order to achieve that you would have to trade 12,398 contracts rather than 10,000!
One thing to note is that both of these trading products offer leverage. This is the key to their popularity and the main similarity. It is also the biggest red-flag that you need to notice.
Trading on leverage means you can control a much larger amount of money than you actually have in your account. This is essential in currency trading unless you have tens or hundreds of thousands of pounds in your account.
If you can only buy £100 in a trade and the price moves up 100 pips (or £0.010) then you only make £1!
This is because as a percentage currencies move very little each day. Rarely moving more than one or two percent. By using 100x leverage, that £100 trade could control £10,000, so when you make 1% you can double your £100.
Of course, if you lose 1% of £10,000 you lose all £100 in that trade, rather than just £1. That’s the dark side of leverage.
The flip side of leverage is margin. You need to have the smaller amount necessary to control that trade available.
Your spread betting broker will calculate how much you are allowed to bet per pip depending on your total account deposit size. You can control a lot of currency in this way and trade for good profits with as little as £500 in your account.
Equally this is what makes leverage dangerous. It is far easier to completely blow up your account when you are using 100x leverage than if you are using no leverage.
This is why people who just buy stocks and shares in the open market don’t often ‘lose everything’. The companies they are buying are unlikely to lose ALL of their value… If they were using 100x leverage then they would only need to see a 1% loss to lose their whole account… (if they were fully invested)
On CFDs, CMC Markets offer a standard 500x leverage on currencies and indices, but 200x on gold. Or at least that is what comes up automatically on many of my trading tickets. On eToro it is different – they offer you a variety of leverage options depending on the product.
So if you are only offered one type of leverage you have to control your risk by instead controlling the amount of contracts you buy.
This gives you two different ways to manage your total exposure in CFDs, but comes to the same £ amount of profit or loss.
Note: If you are CFD trading in £ and you buy a UK denominated product, say the UK 100 or UK Bonds or similar, and you have a GBP based account then you will have no currency exposure. If, however, you buy, for instance, the US 30 on you GBP based account then you will be buying a contract denominated in USD and thus have USD exposure as part of your trade. If you are trading large or with a lot of leverage then this can impact on your trade quite significantly.
In spread betting you just pay £ per pip or Euro per pip depending on what currency your account is denominated in, so there will be no extra currency exposure, keeping it nice and simple!
The key with CFD trading is to pay attention to your order ticket! In Spread Betting it is hard to accidentally bet £10 a pip rather than £1 a pip, unless you really aren’t paying attention.
But with CFDs, given the number of different factors, different contract prices and the currencies they are quoted in etc, you really have to watch the little figure that tells you how much you will make or lose on your take profit target in real money value.
Which Should I Choose?
If you trade in the UK or Ireland then you have the choice of CFD or Spread Bet trading.
The simple answer is that if you can find a Spread Betting broker you like (the Two Blokes trade on CMC Markets) then spread betting is simpler to understand and easier to control your trade amounts.
If you have a slightly more complex strategy, or understand the reasons for wanting to trade CFDs (maybe you wish to hedge and offset your losses against your tax) then you may wish to choose CFDs.
Either way, watch out for that leverage and Happy Trading!
What is the Difference Between CFDs and Spread Betting?