CFD Trading vs Spread Betting Explained

Table of Contents

Introduction

You might be considering CFD (Contract for Difference) trading or Spread Betting but are unsure as to what the differences are between them, particularly as the UK’s Financial Conduct Authority (FCA) which regulates them both, defines a spread bet as being a CFD.

These two trading instruments both offer the potential for profiting from movements in the financial markets, but they can also be confusing for beginners and pros alike, even more so than instruments used predominantly by professionals such as futures contracts. I say that as a professional futures trader with 20 years experience in the City of London, Dubai and Singapore, CFD trading is a bit weird! Maybe bamboozling retail traders (people who trade at home) is part of the plan to slip in extra confusing charges on the unsuspecting – more on that later.

But don’t worry, as always Trader.yt has got you covered! In this article, I will explain the differences and similarities between CFD trading and spread betting, breaking down the basics and highlighting the key features of each. Whether you’re a seasoned investor or just dipping your toes into different trading alternatives, this article will attempt to clear up the much of the confusion. So let’s dive in.

Understanding Spread Betting and CFD Trading

Similarities

At first glance you would be hard pressed to tell whether someone was trading CFDs or Spread betting. The platforms look practically identical, the underlying products their prices are derived from are often the same and you can achieve much the same outcome with either. So let’s first see where they overlap in similarity.

Speculative Trading: Both spread betting and CFD trading are instruments that allow traders to speculate on the price movements of various underlying financial instruments, such as stocks, indices, forex, commodities, bonds and crytpo.

Leverage: Both spread betting and CFD trading allow traders to leverage up their positions. This means that traders can control a larger position with a smaller initial deposit than it would take to buy the full amount of the underlying asset, thereby amplifying profits or losses for relatively minor moves. It’s very similar to taking a mortgage to buy a much bigger house than you could otherwise afford if you were unable to borrow money from a mortgage lender. The gains or losses in the housing market you are exposed to is for the full house value not just your deposit and with that comes the risk of negative equity.

Short-selling: Spread betting and CFD trading enable traders to profit not only from buying things in rising markets but also to speculate on price decreases by taking short positions. Shorting means traders can effectively sell an asset they do not own yet, with the expectation of buying it back at a lower price in the future. This feature allows traders to benefit from a decrease in the price of an asset, if that’s their view, the same way as they can from an increase in price. This is not unique to CFDs and spread bets though, you could do the same with futures contracts on regulated exchanges too (CFDs and spreadbets do not trade on regulated exchanges, bar a failed Australian attempt in 2007 which ran until 2014).

No Ownership of Underlying Assets: In both spread bets and CFD trading, traders do not own the actual underlying assets. Instead, they enter into contracts that reflect the price movements of those assets. This allows traders to gain exposure to a wide range of markets without the need for physical ownership or having to hold the assets themselves. It also means they have no voting rights if the underlying is company stock, nor demands for delivery if they are commodities, because these are all ‘cash settled’ agreements. Having said that both spread bets and CFDs do tend to make dividend equivalent ‘adjustments’ if the underlying instrument pays them out.

Stamp Duty: In many countries, including the United Kingdom, trading a CFD or making a spread bet does not attract any stamp duty, whereas trading the real underlying shares would.

Availability in US: Both forms of trading are generally not available for retail trading in the United States where regulated exchange trades (and associated fees) are demanded. Some argue the CFTC and SEC see CFD trading, even if placed on exchange (as Australia’s ASX tried), as too risky for customers. This argument falls flat when you consider what is on offer to retail traders in the States.

For example the US exchange CME recently embraced binary option betting, purely to entice retail small account gamblers. Offered for a while by NADEX, CME now prefer to refer to them as, ‘Event Contracts‘ – probably due the the shady high risk reputation of the binary options industry in Europe and some spicy reviews of NADEX. They also continue to roll out micro and nano futures contracts purely for speculation to cater to retail demand and stem the tide of US customers trading CFDs offshore.

The US leverage available for on exchange traded futures to retail clients these days is quite astounding. A $500 account with many providers can intraday trade a mini Nasdaq futures contract which has an overnight margin of $16,600, controlling a notional value of $303,758 today! The FCA in the UK and ESMA in Europe impose leverage restrictions of 20:1 on major Indices’ CFDs. The US retail futures trader is getting intraday leverage of 608:1 on major indices!

💡 Key Takeaway: Spread betting and CFD trading share several key similarities. They are both speculative forms of trading that offer leverage on a range of market products, allow for short selling, provide no ownership of the underlying product and do not attract stamp duty. Neither are permitted in the US for retail traders.

Differences

So if they are so similar how are they different?

As we saw earlier, a spreadbet is defined by the UK’s FCA as a, ‘contract for differences that is a gaming contract’. While all CFDs are regarded as investments, spreadbets are regarded as legal wagers. Historically in the UK debts from wagers (gambling) were unenforceable, although now under the Gaming Act 2005 Section 335, ‘the fact that a contract relates to gambling shall not prevent its enforcement’. It also means gambling liabilities can be deducted from inheritance tax in the UK (except in Northern Ireland).

There is an interesting case prior to that legislation where Mr. Leslie claimed the losses he owed City Index from his spread betting were unenforceable but the court ruled otherwise – City Index Ltd v Leslie [1991, 3 All ER 180]. In that case the Financial Services Act 1986 overrode S18 (XVIII) of the Gaming Act 1845.

Gambling is not defined in English law for good reasons but it raises interesting questions such as can you gamble with a financial derivative? In the real world of course you can, toss a coin and go long or short some futures contracts 2 minutes before Non-Farm Payrolls. But can you gamble with a financial derivative in the eyes of the law and the tax man, maybe not? There is good open access paper written by Chris Chen from 2011 exploring spread betting and derivatives and this area titled, “Dividing Hedging and Gambling: Legal Implications of Derivative Instruments” that is well worth a read.

Most providers will highlight the main difference between CFDs and Spreadbetting as CFDs having a fixed contract or lot size to trade with, while spreadbetting is a chosen amount to bet per point with by the user. However most providers offer all sorts of sizes of CFD particularly 1 dollar or pound a point CFDs, very much like you would choose in Spreadbetting so differences are minimal. The other minor difference revolves around expiries which we cover later on.

Tax Treatment Differences

Once it is determined whether the contract of the transaction you enter is a ‘spread bet’ or a ‘CFD’ then the major point to understand regarding their difference revolves around their tax treatment:

CFD net trading profits are considered liable for capital gains tax (CGT) in the UK, Canada, Australia, New Zealand and Germany (Abgeltungsteuer). Although if CFD trading is your main source of income and seen to be run as a business, the HMRC in the UK or other country’s tax authority may decide to apply income tax to those profits rather than CGT. In South Africa it tends to be the other way around, CFD profits are more often taxed as income rather than capital gains.

Spread betting does not currently attract CGT nor Income Tax in the UK either, as it is classed as a form of gambling. In the UK gambling winnings, casino wins, sports bets and lottery pay-outs are not taxed, unlike say the US where they are treated as taxable income. Spreadbetting blurs the line a little between gambling and trading, in that it is not regulated by the Gambling Commission but instead by the Financial Conduct Authority (FCA) who as we have seen class it as a type of gaming CFD.

There are some exceptions where spread betting might attract tax. In places that don’t allow Spread Betting, CFD trading might still be tax free, for example in Dubai spread bets are not allowed (they are only just establishing their first gambling commission now) but there is no CGT in general and no personal income taxes and plenty of CFD providers. In Singapore there is generally no CGT but you may have CFD profits taxed as income if your trading is seen to be run as a business. Spread betting is less common than CFD trading beyond the UK but it is also available in Ireland, Gibraltar, the Isle of Man and the Channel Islands.

Whereas losses on CFD trading can be offset against taxable gains, losses on spread bets can’t. This is quite useful if you are hedging exposures with CFDs against your real stock portfolio.

Spread bets aren’t really used by companies whereas modern CFDs were originally invented to make institutional deal making more efficient (CFD trading itself goes way back to the 1500s).

CFD contracts are tradable and transferable instruments in their own right but spread bets are not able to be traded off to another person.

The Mechanics Spread Betting and CFDs

Why ‘Spread’ Betting?

The “spread” refers to the difference between the buy price and the sell price shown on the trading screen for the instrument you wish to trade. Transaction fees and commissions are not applied to the trade, the broker makes their money from taking the difference between the bid (price they are willing to buy from you at) and ask (price they are willing to sell to you at) of the spread they quote you, hence the term spread betting. It’s very similar to firms selling you different cash currency to go on holiday with at the airport with a big ‘no commission’ sign. They still take their pound of flesh.

How Does Spread Betting Work?

In spread betting, traders place a bet per point of movement in the price of the underlying instrument. They can largely decide the amount of money they want to bet per point themselves, and this determines the potential rate of profit or loss. For example, if a trader believes that the price of a stock will rise, they would place a “buy” bet, perhaps for 50 pence per point, and for every point the stock price increases they make a 50p profit, but only once the price moves in their favour beyond the cost of the spread. Conversely, if the price falls, they would incur a loss for every point it moves against them in addition to the cost of the spread.

Many spread bet providers will also add other charges to the bet particularly if you hold the bet overnight.

How CFDs Work

When trading CFDs, traders enter into a contract with a CFD provider to exchange the difference in the asset’s price from the time the contract is opened to when it is closed, hence their name. CFDs mirror (to an extent) the price movement of an underlying asset, such as stocks, indices, commodities, bonds, crytpo or currencies. They are often also offered based off the futures contract prices of those markets too.

They do not trade on a regulated exchange unlike stocks and futures but are instead traded OTC (over the counter) meaning the broker decides what their price might be at any given time. Australia did try putting CFDs on a regulated exchange for a while to increase transparency in pricing but the idea never really took off. CFDs tend to give a fair representation of what’s occurring in the underlying markets much of the time. A ‘German 30’ will closely follow the Dax Index, the ‘UK 100’ the FTSE100 for example. However, bid ask spreads are determined by the provider and will widen out in periods of volatility, or low demand or liquidity for a particular product.

CFD providers will often bandy around the term DMA which stands for Direct Market Access for marketing purposes. This is usually where the user has access to trade directly on exchange for products such as stocks and futures but as we know CFDs are off-exchange products and traded OTC. You don’t actually get DMA with a CFD provider, not for trading purposes anyway, what they are trying to say is for products like share CFDs they will attempt to show you the real bid ask spread available on the actual stock exchange and then make a market for you OTC at the same price rather than widening the spread. In return for this they will charge you a commission, typically something quite high.

I believe IG charge GBP15 to buy and GBP15 sell a share CFD. Generally for other products such as indices or commodities they will not charge a commission but instead include a much wider spread to bill you for the trade. This will often be marketed as ‘commission free’ CFD trading.

Overnight Charges

In spread betting, there are sometimes no overnight charges associated with holding positions open beyond a day, although a lot of providers will bill additional admin fees and financing fees to hold leveraged bets overnight. CFDs also have overnight financing and admin charges, although if you opt to trade the CFD of the futures contract on the product instead there might not be, but as you guessed the bid ask spread on those will be much wider and often the minimum size you are required to trade will generally be much larger.

The exact cost of overnight charges and admin fees will depend on factors such as the value of the underlying asset and the interest rates set by the CFD provider from prevailing rates and how much they can get away with compared to what their competition offers. If you are trading the CFD of a US stock quoted in dollars then they will convert the currency to GBP from USD and add an admin charge, typically something like half a percent of the conversion rate. So if for example GBP/USD is trading at a rate of 1.22 as it is today (Oct 17th 2023) then 0.0061. General overnight admin fees are typically 2.5-3% of the underlying value over a year, larger charges for smaller contract sizes.

I have written another article going into more depth on overnight share CFD charges here that also has an interactive calculator.

Other Charges

Of course brokers look out for themselves so there can be other charges too, these might include inactivity fees, account annual administration fees, fees for guaranteed stops to be executed at the price you set them at and negative balance protection if you want your account not to lose more than you funded it with.

Regulatory Compliance

Both spread betting and CFD trading are regulated financial activities. In the United Kingdom, both spread betting and CFD trading is regulated by the Financial Conduct Authority (FCA), as well as other regulatory bodies in different countries. It’s important to choose a reputable and licensed provider to ensure the security of your funds and adherence to regulatory guidelines. If you open an account in a place like Bermuda, Vanuatu, Belize or Panama you can expect much higher leverage but much less protection.

CFD providers can blow out spectacularly, Alpari was one that comes to mind and the desperate fumbling rescue of FXCM when it was on the ropes in early 2015 after the Swiss franc move is another.

💡 Key Takeaway: Taxation and legal considerations play a significant role in deciding between spread betting and CFD trading.

Understanding the Market Price and Expiry Date in Spread Betting and CFD Trading

In both spread betting and CFD trading, understanding the market price and expiry date is crucial for making informed trading decisions.

Market Price

The market price refers to the current value of the underlying asset. It represents the price at which traders can buy or sell the financial instrument. The market price is influenced by various factors, including supply and demand dynamics, market sentiment, economic indicators, and geopolitical events.

In spread betting, the market price consists of the bid and ask prices that get created around the underlying price. The bid price represents the price at which the spread betting provider is willing to buy the asset, while the ask price is the price at which they are willing to sell it. The difference between the bid and ask price is known as the spread, and it represents the provider’s profit margin.

In CFD trading, the market price is also determined by the bid and ask price. However, unlike spread betting, CFD traders are sometimes offered prices matching the underlying market, particularly for shares (often marketed somewhat incorrectly as Direct Market Access) but then pay a commission to the broker rather than just a spread. This allows CFD traders to access market prices that closely reflect the real-time fluctuations of the underlying asset.

Remember the prices quoted to you are usually not what is happening exactly in the underlying market, for example take the Bund future which is a German government bond and highly liquid, FXCM will quote a 6 tick wide bid ask spread i.e. 50 bid at 56 offered whereas if you look at the actual futures market data feed you will see it has no spread, it might be 52 bid at 53 offered. This is where the broker makes their money. You might think so what? I’ll be putting together an article comparing conducting the same trade on exchange traded futures vs CFDs and show how commission free CFD trading can in reality be far more expensive than doing a futures trade with all associated fees.

Expiry Date

The expiry date is another important aspect to consider. It refers to the date at which a position or contract is automatically closed if it hasn’t been closed manually before that. The expiry date varies based on the specific financial instrument and the terms set by the spread betting provider or CFD broker.

Spread Betting

In spread betting, there are generally fixed expiry dates for all positions. Providers tend to offer daily bets or quarterly bets, both of which can be rolled into the next expiry if required but doing so may accrue overnight or extra roll fees. Therefore the daily bets are good for quick intraday moves whereas if you want to take a longer term view it is cheaper to go with a longer expiry bet. Traders can choose to close their positions at any time prior to the expiry.

CFD Trading

In CFD trading, the expiry date is determined by the contract specifications. Some CFD contracts have a fixed expiry date particularly if they are based on underlying futures expiries, while others are open-ended. It’s important for CFD traders to keep track of the expiry date, if any, and decide whether to roll over the contract or close the position before the expiration. If you have a longer term view, CFDs based on futures contract expires tend to be more cost efficient than holding the ‘cash’ version trades for multiple days.

Risk Management in Financial Spread Betting and CFD Trading

Risk management is a crucial aspect of successful financial spread betting and CFD trading. Both these trading methods involve a certain level of risk due to their leveraged nature, but with proper risk management strategies, traders can mitigate potential losses and maximize their chances of success.

Understand Your Risk Tolerance

Before engaging in spread betting or CFD trading, it’s important to assess your personal risk tolerance. Risk tolerance refers to how comfortable you are with the possibility of losing an amount of money. Evaluating your risk tolerance will help you determine the size of your trades and the level of leverage you are willing to utilize. Don’t risk more than you can afford to lose.

Set Stop-Loss Orders

Stop-loss orders are key risk management tools. By setting a stop-loss order, you can predetermine the maximum loss you are willing to accept on a trade. If the market moves against your position and reaches the specified level, the trade will be automatically closed, limiting your potential losses. This is especially important in volatile markets where prices can fluctuate rapidly. Some providers will offer ‘guaranteed stops’ for more money meaning they guarantee to get you out at the requested price. Normal stops are open to slippage meaning if a lot of other orders are hitting the market at the time or the product is very illiquid the chances of getting you originally requested price are much lower.

Diversify Your Portfolio

Diversification is a fundamental risk management technique that involves spreading your investments across different asset classes, markets, and instruments. By diversifying your portfolio, you can reduce the impact of individual losses and potentially offset them with gains from other positions. In spread betting and CFD trading, diversification can be achieved by trading multiple instruments across various sectors. Remember markets are corelated, do you really need to be short the Dow, SnP, Nasdaq, FTSE and Dax all at once as they often do the same thing.

Practice Proper Position Sizing

Proper position sizing is the art of determining the appropriate amount of capital to allocate to each trade based on your risk tolerance and overall account balance. It ensures that you don’t risk too much on any single trade, which can help protect your capital.

Utilize Risk-Management Tools

Many spread betting and CFD trading platforms offer risk-management tools to help you manage your trades. These tools may include guaranteed stop-loss orders, trailing stops, and limit orders. Utilizing these features can provide an added layer of protection against sudden market movements.

Stay Informed and Keep Learning

Keeping up with the latest market news, trends, and analysis is crucial for effective risk management. It helps you make informed decisions and adjust your trading strategy accordingly. Continuous learning about different risk management techniques can help you refine your approach and adapt to changing market conditions.

💡 Key Takeaway: Effective risk management is essential in financial spread betting and CFD trading. By understanding your risk tolerance, setting stop-loss orders, diversifying your portfolio, practicing proper position sizing, utilizing risk-management

Summary

While both options offer potential for profit, it’s crucial to consider factors such as tax treatment, overnight charges, position sizes and availability in different countries. Spread betting allows you to speculate on price movements tax free in the UK betting an amount you choose per point, while CFD trading involves buying or selling fixed sized contracts based on the price of an underlying asset and attracts capital gains tax. Depending on your trading goals, tax situation and risk appetite, you can choose the option that suits you best. Remember, being able to offset capital gains tax with CFDs can be handy for hedging underlying exposures. It’s important to consult a tax advisor to fully understand the implications in your jurisdiction.