With so many different markets on which you can trade and so many different ways to go about it, you could be forgiven for not knowing all the little ins and outs of the trading world. One aspect of trading never changes though and that is you either buy low and sell high or buy high and sell low (the latter is explained later). Two popular ways of doing so are with CFDs or by spread betting, but what are the differences?
A ‘Contract for Difference’ or CFD is an instrument used to trade without actually purchasing any underlying assets. Profits or losses are made in relation to the stock price and whether it rises or falls in the time between when the contact is entered and exited. So, put simply, if you buy at $50 and predict that the price will go up, it does, and you then sell at $60 you will have made a $10 profit.
Spread betting is a little different, again you are not actually purchasing any assets, you do speculate as to whether the price of stock will rise or fall in much the same way, but you then attach a figure to each point that the stock rises or falls. So if you ‘go long’ to the sum of $10 per point when the stock is worth 100 points and it rises to 120, you will have made $200 and if it falls to 80 points you will have lost $200.
Online trading platforms, such as ETX Capital, specialise in offering their customers access to thousands of markets and the opportunity to use CFDs and to take part in spread betting. They are safe to use, as they are regulated by the Financial Conduct Authority and have user-friendly software that can be used on desktops, tablets and smartphones. In addition, they provide great customer support and even free educational packages to their clients.
Advantages and Disadvantages of CFDs and Spread Betting
Going Long or Short – both CFDs and spread betting allow you go long, in other words you predict that the price of a particular stock will rise and when they do, you sell them at a profit. Alternatively, you can go short, where you predict that the price of the stock will fall. The process of shorting, involves borrowing assets from a broker and then immediately selling them. When the price of the assets fall, you repurchase them at the lower price, then you return the assets to the broker and pocket the difference.
High Leverage – leverage means that you only have to pay a small amount of the actual trade value upfront and this is called a margin. CFD and spread betting margins can be as low as 0.25%, so for example, if the total value of a contract is £100 you would only have to put up a 25p deposit, whereas if you were to buy the shares subject to a traditional brokers contract with a 50% margin, you would need to make an upfront payment of £50. It is also worth bearing in mind that CFDs come with a financing cost on top of the margin.
Exposure to Markets – such low margins mean that when trading CFDs or when spread betting you may be able to access markets that normally you would be priced out of. In turn, this gives you the freedom of choice and the ability to cherry pick the markets you know the most about. For example, you may be more au fait with the foreign exchange markets than you are with commodities.
Tax and Profits – the money you make by spread betting is not subject to Stamp Duty, meaning that you pay no tax on your profits. CFDs are, however, taxable, but should you incur losses, these will attract tax relief. So here there is a swings and roundabouts scenario that is worth considering carefully before you decide how you will approach an investment.
The Spread – a spread is the difference between the market price for a particular stock or other type of security and the price paid by the client, you, to the broker. For example, if the market price of a stock is £100 and the spread fixed by the broker is 0.5 points, then at the time of the transaction, 50p will be deducted from the position value and therefore if the market price has not changed, your position value will be £99.50. The easiest way to think of a spread is to look at it as a commission that is taken at the start of transaction and not at the end.
Hedging – hedging is a way of protecting any physical investments you may have. CFDs are often used as a way to hedge investments. It works by the investor, you, predicting that one or more of your long investments may perform badly in the future and make a loss. Taking out a CFD on the same stock, but as a short, means that any potential loss from your original, long investment will be offset by the CFD short and leave you on a level playing field in terms of your equity. Spread betting is also used to hedge other positions, but this tends to be the case more so with shorter investments.
Whilst on face value CFDs and spread betting are very similar, there are some subtle nuances that you should take into account. The biggest difference between CFDs and spread betting is the fact that CFD profits are taxed, while profits from spread betting are not.
Another thing to consider is that experts generally agree that for beginners or those with little experience, spread betting is said to be a better way to trade. CFD trading is said to be more suited to more mature traders who invest long term.
Whichever method you decide to use, do your homework and make sure you know all the facts and figures before you decide to take the plunge and invest your hard earned cash.