Reviewed by Patrick Foot, Senior Financial Writer.
- What are spread betting and CFD trading?
- How spread betting works
- How CFD trading works
- The differences between spread betting and CFD trading
- Spread betting vs CFDs: which is best?
- Example trade: Microsoft
- FAQ
What are spread betting and CFD trading?
Spread betting and CFD trading are both a type of financial product called a derivative. In trading, a derivative simply means a product that enables you to take a position on a market without taking ownership of the asset itself.
When you open a spread bet or CFD trade on gold, for example, you don’t actually buy any bullion – but you still get exposure to the precious metal’s price movement.
The means that both spread betting and CFDs share a few powerful benefits:
- Both are leveraged. You aren’t buying assets outright, so you don’t need to put up their full value to open a position. Instead, you just need a small deposit in your account known as your margin
- Both enable you to go short. Going short gives you a position that earns a profit if your market’s price falls, and a loss if it rises. It can be useful for hedging, and doubles the trading opportunities you can access at any time
- Both come with some significant tax advantages – although tax works differently with each. We’ll cover this in more detail later*
- Both give you access to 1000s of markets from a single account. You can use spread betting and CFD trading to buy and sell forex pairs, commodities, stocks, indices, bonds and more
Those are the similarities between CFDs and spread betting, but what about the differences? Well, the main difference between them is how they work. Let’s take a closer look.
How spread betting works
Instead of buying then selling a market, you bet a certain number of pounds per point (known as your stake) on whether it’s going to rise or fall in price. For every point that the market moves in your chosen direction, you earn your stake as profit. For every point it moves against you, you make a loss.
Say, for example, that you want to trade Twitter. You could bet £2 per point long on the stock, which would give you a position that earns £2 for each point Twitter’s share price rises, and loses £2 each time it falls.
Or, you could bet that Twitter will fall instead. Here, you’re earning £2 for every point that Twitter falls, and losing £2 when it rises.
Just like a traditional trade, you only realise your profit or loss when you close the position. If Twitter has fallen 50 points when you close your short trade, you’ll make (£2 x 50) £100. If you’d gone long, you would be facing a £100 loss.
Learn more about the mechanics of spread betting.
How CFD trading works
CFD trading works a little bit differently to spread betting. You’re buying and selling a contract that mimics the price movements of its underlying asset.
This contract entitles you to exchange the difference between the asset’s price from when you open your position to you close it. If you buy a Wall Street CFD (which tracks the Dow Jones) at 35,400 and sell it at 35,500, you’d make (35,500 – 35,400) $100. Or if you sell at 35,300, you lose $100.
To go short, you simply sell CFDs instead of buying them. You’ll still be exchanging the difference in the price of the underlying, but here you make a profit if the difference is negative and a loss if it’s positive.
You decide how many contracts to buy or sell to set your position’s size. Each CFD usually mimics buying its underlying market. Buying an Apple CFD, for instance, gives you the same exposure as buying an Apple share.
The differences between spread betting and CFD trading
The main difference between spread betting and CFD trading is how they work, but this brings a number of unique features and benefits to each. Spread betting, for example, is more tax efficient – while CFDs can be closer to traditional trading.
Spread betting |
CFD trading |
|
Availability | Available to traders in the UK and Ireland only | Available globally, except in the US |
Tax | Exempt from both capital gains tax (CGT) and stamp duty* | Exempt from stamp duty only* |
Commision | No commission on any positions | Commissions on equities |
Trade size | £ per point | No. of contracts |
Profit/loss | No. of points the underlying market has moved, multiplied by your stake | Difference between the contract’s open and close prices, multiplied by no. of CFDs |
Currency | All profits are in pound sterling, unless you change your account’s base currency. No currency conversion | Profits are in the currency of the underlying market, then converted into your account’s base currency |
Spread betting or CFD trading: which is best for me?
Deciding whether to spread bet or trade CFDs depends on your trading style and goals. You can use this quick recap of the benefits of both to help you pick.
Remember, though, you don’t have to use one product exclusively. To access both CFDs and spread bets from a single platform, simply select both options when you open your City Index account.
Benefits of spread betting
- Better tax efficiency. While CFDs are free from stamp duty, spread betting is free from both stamp duty and CGT*
- Commission-free trading. All costs to open and close positions are contained within the spread – you’ll never pay commission
- No currency conversion. When you spread bet, your stake is always in pounds per point, so you don’t have to take currency conversion into account
Benefits of CFDs
- Closer to traditional trading. Buying a CFD is similar to trading the underlying market itself, which can make it more familiar than spread betting if you’re an experienced investor
- Hedging. CFDs are a popular tool for hedging, where you offset risk by opening a position that earns a profit if your existing trade earns a loss
- No stamp duty. While you still pay capital gains tax on CFDs, they are free from stamp duty
Spread betting vs CFD trading example
Want a bit more clarification on the differences between spread betting and CFD trading? Follow along with this step-by-step example on Microsoft.
Microsoft stock is priced at $301.5, but you think it’s going to fall. To profit from the drop in price, you can either open a short spread bet or sell Microsoft CFDs.
Shorting Microsoft with spread betting
Microsoft’s spread betting market is listed in points – with a sell price of 30145 and a buy price of 30155. You want to go short, so you bet £1 per point at 30145.
Your prediction is correct, and MSFT stock falls to 291.5, meaning its spread betting market is now priced at 29145/29155. To close your position, you need to net off your exposure by buying £1 per point at 29155. The market has moved 990 points in your favour, earning you (£1 * 990 points) £990.
All your costs to open and close the trade are covered in the spread, so there’s no commission to pay. If you’d kept the position open for more than one day, though, you would have to pay overnight financing.
Selling MSFT CFDs
Microsoft CFDs have a much tighter spread, and they’re priced in USD, giving you a sell price of $301.49 and a buy price of $301.51. You choose to sell 100 CFDs at $301.49.
MSFT falls to $291.49/$291.51, and you close your trade by buying 100 CFDs at $291.51. The difference between the two prices is $9.98, so you earn $9.98 for each of your 100 CFDs – a profit of $998.
The City Index platform will then automatically convert your profits into pounds.
However, this is a share CFD trade, so you would also pay commission, which would impact your net profit. Commission on US stocks is 1.8 cents per share – but here you’d pay the minimum commission of $10, giving you a total profit of $978.
As with the spread bet, you’d pay overnight financing if the position is open for more than one day.
Spread betting vs CFD trade
You decide to go short on Microsoft shares at a price of $301.5.
Spreads |
|
---|---|
Spread bet stake | £1 per point |
Spread bet notional value | £30,145 |
Initial margin (20%) | £6,029 |
MSFT stock falls to $291.5. | |
Gross profit | £990 (Commission £0) |
Net profit | £990 |
CFDs |
|
---|---|
CFDs bought | 100 |
CFD notional value | $30,149 |
Initial margin | $6,029 |
MSFT stock falls to $291.5. | |
Gross profit | $998 (Commission $20) |
Net profit | $978 |
* Spread Betting and CFD Trading are exempt from UK stamp duty. Spread betting is also exempt from UK Capital Gains Tax. However, tax laws are subject to change and depend on individual circumstances. Please seek independent advice if necessary.