What are the key differences between CFD and Spread Betting?

As the world’s financial markets have continued to evolve, so too have the various ways in which individuals can invest and look to increase their capital holdings.

Two of the most popular investment vehicles are contracts for difference (CFDs) and spread betting, each of which represents leveraged derivative products whose values derive from an underlying asset.

Commonly used to trade currencies and similar assets, both offer considerable value to different types of traders. But how does each option work, and what are their core advantages?

What are CFDs?

CFDs are derivative contracts between investors and financial institutions, in which investors take a position on the future value of the underlying asset. This enables them to trade without assuming ownership, affording them the freedom to profit even in a depreciating market.

There is no delivery of physical goods or securities with CFDs, but the contract itself boasts transferable value when it’s enforced.

As a result, the CFD is a tradable and intrinsically valuable security that’s established between a client and a licensed broker.

CFDs trade over the counter through a network of brokers that organise the market supply and demand for CFDs, with this regulating prices in real-time.

What’s Spread Betting?

Spread betting is similar to the CFDs in that they allow investors to speculate on specific market and asset price movements, with differences in the cash settlements used to cover the difference between open and closing trade prices.

Through spread betting, you can speculate on a diverse array of financial instruments, including forex and commodities along with stocks and fixed income securities.

In terms of functionality, spread bettors will effectively place a ‘bet’ on whether they think the market will rise or fall within a predetermined time-frame. They’ll also get to set the value of this bet in both bull and bear markets, while spread betting completely taxes and commission-free (enabling investors to make the most of their capital holdings).

There are spread betting companies that provide buy and sell prices to aspiring investors in real-time, while this simplified investment vehicle is widely used by beginners when they first participate in the forex market.

What are the Pros and Cons of Each Option?

Both CFDs and spread betting offer access to leverage, meaning that investors can open relatively large positions with small deposits and initial margins.

The level of margin generally varies from 0.5% to 10% of the value of the open position, while margin rates increase incrementally for less risky assets such as stocks.

Both investment vehicles also carry inherent levels of risk, as while the potential profits may well be 100% equivalent to the underlying marketplace, losses can also reach a similar level. This means that stop losses may be required to manage risk and curb losses before they reach a predetermined level, so you’ll need to keep this in mind regardless of which option you choose.

In terms of pros and cons, CFDs can be completed directly within the market, helping investors to avoid enjoying more transparent and simplistic trades. Conversely, spread betting is done through a broker, creating a more rigid way of executing orders over time.

We’ve already touched on the fact that spread betting completely taxes and commission fees, but the same cannot be said for CFDs.

In fact, CFD trading requires investors to pay commission charges and direction fees to their chosen brokerage site, and this is a major consideration for traders given how it can eat into their profitability.