If your residence is outside of the US you have a variety of retail derivative markets to trade. The 2 most popular options for Forex and indices trading are Contracts for Difference (CFDs) and Spread Bets. Though CFD and Spread Betting brokers operate very much the same way, there are some key differences.
What are CFDs?
CFDs are an agreement (or contract) between 2 parties (usually a broker and a client) that allow buying and selling of a financial product. These products are usually currencies (Forex), indices, commodities and stocks. CFDs are a derivative, meaning that they are not traded on an exchange and are usually a product that mirrors the price of an underlying asset. For example, purchasing a CFD contract of Barclays will not result in you owning any Barclays shares. The CFD market of Barclays shares will mirror that of the actual share price but will not involve you owning any shares in Barclays. The contract is simply between you and the broker.
What is Spread Betting?
Spread betting also allows a brokerage client to trade Forex, indices, commodities and stocks. Spread bets are also a financial derivative and allow buyers and sellers to speculate price movement through betting.
So, what are the differences between CFD trading and Spread Betting?
The biggest and main difference between CFDs and Spread Bets are that CFDs are considered speculative trading products, spread bets are considered gambling. Though both derivatives are traded very similarly, one is classified as gambling and one is not. Because of this difference in classification, the following apply...
Tax (if in the UK)
CFDs are liable for Capital Gains Tax. Spread betting is tax-free and any gains or losses are not to be accounted for. If spread betting becomes your main income then your profits will be liable for income tax. To learn more about UK tax on Forex trading profits, please read my UK tax on Forex trading post.
CFD prices are usually quoted as per the underlying asset. Spread bets are usually quoted in point values.
CFD contracts usually match the contract size of the underlying asset, for example 1 CFD contract of the UK100 will match the value of 1 futures contract of the FTSE. Spread betting allows betting an amount per point, which provides greater flexibility.
Guaranteed stop losses are usually not offered by CFD providers. Spread Betting brokers usually offer guaranteed stops, these do incur a premium charge though and are not free.
Spread betting allows you to earn tax free profits (if a secondary income) and allows you to limit risk through using guaranteed stop losses. For these reasons many choose spread betting over CFD trading. If trading becomes your main source of income, CFD trading can be more cost effective - in the UK Capital Gains Tax has a lower tax rate than income tax.
Either way, CFD trading and Spread Betting allow traders to profit from the financial markets using simple trading platforms and at a minimal cost.
If you have found this post interesting, I suggest watching Does my Broker Trade Against Me?!