Difference Between CFD and Spread Betting Trading
CFDs VS Spread Betting
CFDs are known as Contracts for Difference, and they are professional trading instruments that many seasoned traders and investors use. First and foremost they use CFDs because of the need to hedge downside risk on a stock that they already own. You can practically hedge that risk with spread betting too, but there are some differences. CFD pricing mirrors exactly the movement and contract size of any market, such as that stock, it’s very much like trading that actual stock. Whereas with spread betting you buy or sell certain amount of money per point, and you will have to calculate how much that amount needs to be in order to hedge a long stock, or have the equivalent of a long stock investment. With CFDs you don’t have to do this calculation since the quoted markets work just like the real underlying market where you just decide to buy or sell X number of shares of this or that stock. Also, CFDs don’t have expiry dates, you simply buy and sell, and hold for as long as you like. Spread betting contracts bear similarities to Futures trading, and have expiry dates.
In fact, the very reason why you cannot trade many markets through Futures, is because of the way Futures are priced, and spread betting is similar in pricing. Futures were originally invented for commodities, and their pricing takes into account future demand and supply, not just today’s demand and supply, that’s why Futures prices can deviate so much from time to time, from the spot market price. Spread betting doesn’t really work for short term trading because of this reason, and also because of the high cost of the spreads.
Direct Market Access (DMA)
CFDs offer direct market access, even though they are not exactly the real market, they offer access to the real market with almost perfect liquidity. And not only that but this liquidity brings all the good of the real market while leaving all the bad out. This liquidity is always there and it works well for trading size up to about to the equivalent of $100 per point / cent. So it meets the needs of all retail traders, but investment banks and large traders cannot use CFDs because they trade at very large size, hence they don’t have these unfair liquidity advantages either. Spread betting does not offer direct market access, is more of a market maker type of trading, hence liquidity cannot be as good as that of CFD.
Direct market access is offered in CFDs, through the CFD brokers infrastructure and sophisticated liquidity pool, which is constantly improving thanks to strict standards and competition among brokers.
Moreover, CFDs allow you to completely eliminate slippage and requotes through the use of Limit type orders, some spread betting brokers but not all, do offer this as well. In actual trading you will find that whenever market conditions are tough you will never get the price you want in spread betting, only CFDs will work.
CFDs incur commission charges and are subject to income tax because they are classed in the same way, as if you are trading the real underlying markets. Spread betting is tax free up to this point, but in reality brokers pay tax in the form of license fees, and there’s a hidden commission also, which is absorbed in the spread. So overall, spreads are wider with spread betting. This is important, because in fast day trading and scalping you cannot possibly be successful with spread betting, only CFDs will offer the best price, and tightest spreads for such fast trading. For longer term trading, spread betting can still work. In terms of affordability and leverage, both types of trading offer high leverage and can be very affordable.
But you have to choose carefully based on liquidity and spread size considerations. Even though you may have to pay tax on CFDs, probably as much as 30% on your profits, depending on the country you are in, CFDs are still better than the supposed tax free spread betting, because the hidden charges of the wider spreads and inferior liquidity will actually cost you more than 30% in the long run. Also, large profitable CFD trades make significantly more money than the same trades implemented through spread betting. And the higher the frequency of trading the better CFDs will be.
In reality, CFDs are more cost effective than anything else out there, there are only few cases of trades where the trader is better off with spread betting.
So Which to Use?
Spread betting is good to use as a toy, as a new trader, to get a feel of the markets and plan some basic trading strategies. When it comes to serious trading, you can still use both CFDs and spread betting, as part of the same strategy, or simply use well calculated spread betting trades to temporarily hedge an open CFD trade which is going through a losing period.
It’s unlikely that you will make millions from spread betting alone, no matter how good you are as a trader, because some strategies are impossible to implement with spread betting, such as scalping for example. Accurate and efficient trading is required, in order to make millions, and this means perfect liquidity and price linearity, which spread betting cannot offer in real time.
There are cases however where it’s possible to open longer term spread betting trades, and then hedge or do fast trades in the opposite direction, with CFDs, that can work.
Regardless of how you choose to trade, spread betting is a crude, simplistic way to trade, and it’s better suited for slow trading, which in some cases it is actually desired. In some slow trades, lasting several days or more, you actually want to keep complexity down and treat markets as a simple game.
Moreover, CFDs are quoted in the same currency as the underlying asset, so CFDs in gold are quoted in US dollars, and various stocks and commodities are quoted in their local currencies, whereas spread betting always works with the base currency of your trading account. This is one case where new traders who don’t understand forex, and wish to hold trades for many weeks, are better off using spread betting, to avoid any fluctuations in the related currencies. Wise CFD traders always pay attention to the quoted currencies, so gold CFD traders will always check the direction of the US dollar, and will either trade CFDs on gold for few days at a time, or will make some long term trades where they will also hedge US dollar risk, through a CFD trade on the forex market.
Making Millions in the Right Market
Wise traders and investors are usually people who spend many years studying one particular market, so as to become experts in that single market. They are known as specialist traders, and the more complicated a market is, the more information you can find about it, and the easier it is to become a specialist. Commodity traders are specialists and most of them trade very carefully, taking into account both forex and commodity market trends. Some specialist traders, trade grains or energy commodities, and these do offer phenomenal opportunities from time to time.
Sugar for example is one commodity which tends to offer some predictable solid trends, and these trends can be detected early by specialist traders who know this market well. These traders use CFD contracts to capture the main trend, as well as additional CFD trades to capture smaller movements in the same direction. In this case, there’s no need to hedge downside or upside risk because these commodities are in very solid trends. This is unique to commodities because they have finite supply and guaranteed demand. It’s because sugar is in demand, and nobody can just print more sugar, as is the case with shares or national currencies. Trades like this can be implemented with spread betting, but only on their long term part where volatility is less.
In reality, the more volatile a market is, the more you want to use CFDs, to be able to trade efficiently and accurately. And the less volatile a market is, the more you can use spread betting to trade, and achieve the same results. But as we all know volatility never drops below certain levels, and it always makes trading confusing.
Making millions with spread betting alone is very difficult, a good trader can still make money with spread betting, consistently, but only on slow trading strategies, fast trading will not work. Moreover, as one learns more and more about commodity trading and Futures pricing, they may consider using Futures pricing as a way to gauge demand, at extreme price levels, but the best way to actually trade that market will be through CFDs. In that regard, spread betting is just a fancy toy Futures contract, one which is inefficient and non linear. And the more complicated the strategy, the more one finds that only CFDs can provide the maximum possible profitability.
You can also tell spread betting is intended for beginners, by the way brokers entice new clients, so as to make everything user friendly, offer promotions and bonuses. But profitable trading that will make you millions is not really user friendly, most profitable strategies are very hard to understand, and even if revealed, most new traders would not be able to follow them at all.
More Ways to Trade Both CFDs and Spread Bets
In reality, traders can combine both CFDs and spread betting in strategies where both fast and slow trading is wanted. Spread betting can facilitate the long lasting trade, whereas CFDs can facilitate the fast trades. You can think of spread betting as a crude Futures contract, but over many days or weeks, the market may move a lot, so it’s okay for the spread betting contract to be off by few dollars, relative to spot market price. But on the CFD part, you can be very accurate, you can open multiple trades, and trade smaller trends and price deviations on the same market.
There’s no rule that says you should use only one or the other, you can use both types of contracts to implement your trading idea. Just be mindful of the differences because that’s all there’s to know, and brokers may not explain these things clearly enough to you.
All brokers give simple trade examples, so as to make you understand how to place a simple trade, but there’s much more to trading than simply buying low and selling high, in one time frame. There are many time frames and many minor trends to consider. Scalping for example is only possible through CFDs, but you can cover breakout risk through spread betting, and there are entire forex scalping strategies around this concept alone.
CFDs are by far better than many spot markets themselves, and more affordable than trading these actual underlying markets. Taxation applies to CFDs, but only on profits, no tax is paid when you deal shares through CFDs. In the UK, investors have to pay stamp duty on every share dealing, plus capital gains tax on any profit realized. CFDs get around stamp duty costs, which can be a lot of money in high frequency trading, but capital gains tax still applies. Profitable traders however are not very concerned about capital gains tax, because the benefits of tighter spreads and close, coherent pricing that CFDs offer, this pricing actually helps increase their profits dramatically, and it’s the biggest benefit of CFDs that spread betting doesn’t have.
CFDs are instruments intended for use by professional and specialist traders, traders who already know the basics of the forex market and the commodities market. Whereas spread betting is more intended for use, by traders who implement simple strategies.
Spread betting is good for medium term trades only and doesn’t work on fast trading. CFD works in every case, but for prolonged trades you need to pay attention to the quoted currency, which may change over time.