CFD ("Contract For Difference") Trading and Spread Betting
What is CFD Trading & Spread Betting?
Types of Investments
- Exchange Traded Funds (ETFs)
- Foreign Exchange (FOREX)
- Gilt Edged Securities (Gilts)
- Investment Trusts
- ISAs (Individual Savings Accounts)
- Listed Contract for Difference (CFDs)
- Real Estate Investment Trust (REIT)
- Stocks & Shares
- Spread Betting & CFD Trading
- Unit Trusts & OEICs
CFD ("Contract For Difference") trading and spread betting are methods of investing in derivatives – that is, financial instruments that vary directly according to the value of underlying assets at any time – and there are some similarities between them.
A CFD is an agreement between an investor and a broker to exchange the difference between the value of an underlying asset – a share, commodity or stock market index, for example – at the time the contract was opened. The important point to note is that a CFD mirrors the value of an underlying asset, allowing an investor to trade that asset without actually having to own it.
Similarly, spread betting is not a method of trading assets, per se, but it does, nevertheless, allow an investor to gamble on the movement of a stock, index, etc. without owning an underlying share. A spread bet is opened, and closed, at a price determined by the value of the underlying asset, quoted by a spread betting, or indexation, company.
Contract For Difference (CFD) versus Spread Betting
There are a number of important differences between CFD trading and spread betting, however. Perhaps the most important of these are the nature of the spreads on offer and, in particular, the "bid-offer" spread. A CFD spread is likely to match exactly, or approximately, the "Stock Exchange Electronic Trading System" (SETS) or "Order Book" value of an underlying asset, whereas a spread betting spread is determined, solely, by the spread betting company. A spread betting company quotes its own, fixed, buying and selling prices, on a "take it or leave it" basis; a CFD provider, on the other hand, may offer greater flexibility, by allowing orders to be posted within the bid-offer spread.
Typically, CFDs are cheaper to trade than a spread bet, particularly in the case of multiple, short-term trades. An investor opening a CFD position does not need to pay the full value of the underlying asset but puts up a deposit – typically of 10% or more of the total value of the position – which means that he, or she, can trade up to ten times the value of the initial capital invested. Another advantage of a CFD, if an investor holds a "long" position – in the expectation that an asset will rise in value – he, or she, receives any dividend issued on the underlying asset.
The decision to close a CFD position is purely at the discretion of an investor, but spread bets have a fixed expired date on which the position is closed regardless of any profits or losses. Any profits realised on CFD investments are liable for Capital Gains Tax, whereas profits from spread betting are 100% tax-free. Most spread betting firms also offer "stop loss", or "guaranteed stop loss", accounts, which limit the value of potential losses, and winnings, to a level determined by the individual investor. It may therefore be worthwhile for an investor to open both a CFD and a spread betting account to allow the relative merits of each to be assessed in relation to any given trade.