How spread betting and CFD trading work
Why do people spread bet
We've looked at what spread betting is and how it works, but you may be wondering about the advantages of placing a spread bet rather than trading in the more traditional way. Let's take a look at the reasons to choose spread betting.
When you trade financial assets in the traditional way, you normally have to pay capital gains tax (CGT) on any profits you make. However, spread betting is classed as gambling, which is exempt from CGT.
It's also free from stamp duty - a tax you typically face when trading shares. That's because you never physically own any shares with spread betting, you just bet on their value.
Remember that tax laws are subject to change and depend on individual circumstances. Tax law may differ in a jurisdiction other than the UK.
If you trade physical financial assets through a broker, you'll normally pay commission. This doesn't apply with spread betting as the charges are typically included in the spread.
Since brokers often charge a minimum fee for every transaction, paying a spread is usually cheaper than paying commission on an equivalent transaction, particularly for smaller deal sizes.
Capitalising on falling markets
In traditional trading, you normally buy an asset in the hope its value will rise, so you can sell for a profit. However, with spread betting you can equally well take a view on an asset you expect will fall in value - known as going short.
As you're simply betting on the direction you think a price will take, you can keep dealing even in bearish markets.
Thousands of markets
With traditional trading, you might have to use separate brokers specialising in different asset types, such as shares or foreign exchange. However, most spread betting providers offer a diverse range of global financial markets, all together on a single platform.
You can also spread bet on markets that are difficult to access in other ways. Stock indices, for example, can't be bought or sold directly, but you can spread bet on their movements.
Most markets have set dealing hours. The FTSE 100, for example, is only open from 8am to 4.30pm in the underlying market. Ordinarily, after it closes for the night, you'd have to wait until the following morning before you can deal.
You may, however, find that some spread betting providers allow you to deal round-the-clock on certain markets. This means that, even if the market you're betting on is shut, you can still open and close your bets.
With conventional trading you generally need to pay the full purchase price of an asset up front. Spread betting, however, is a leveraged product. So when you place a spread bet your provider will ask you to put up a sum representing just a fraction of the total value of the position.
Leverage gives you a relatively large exposure to a market with just a small deposit.
Imagine you wanted to spread bet on gold:
- Without leverage, buying one ounce of gold might cost £800
- But your spread betting provider only charges an initial deposit margin of 1%
- This means you need to put down a deposit of just £8 to open a position on an ounce of gold
IncorrectWhen you trade shares without leverage, you have to put down their full value. In this case that's £5 x 200 = £1000.
IncorrectThe upfront cost of this trade is 5% x £1000 = £50.
The risks of using leverage
Leverage can work to your advantage when you spread bet, however it's important to remember that both profits and losses are based on the full size of your bet. This means they could far outweigh the size of your initial deposit. So leverage is a benefit of spread betting, but also its biggest risk.
You can look at leverage in more detail in the orders, execution and leverage course.
- Spread betting profits are tax free and exempt from stamp duty. (Tax laws are subject to change and depend on individual circumstances. Tax law may differ in a jurisdiction other than the UK.)
- You can go either long or short
- Spread betting gives you access to thousands of markets in one place
- You can spread bet 24 hours a day on some markets, eg forex and major stock indices
- Spread betting is a leveraged product so you don't have to put up the full value of your position. As such, both your profits and losses may be magnified in relation to your initial deposit