CFD trading versus Spreadbetting mercXXXedes 2015-01-30T15:43:13+00:00

Trading CFDs

CFDs, standing for Contracts for Difference, are a very popular trading instrument for several reasons: CFDs enable you to leverage your exposure to the market without paying stamp duty on UK shares.

Similar to spread betting, you can bet on the direction of a share without actually owning the underlying. You can also take advantage of falling prices by being short a share.

When you trade CFDs you can gear up, typically by only putting 20% of the capital up for the trade. For example, if you wanted to purchase $10 000.00 of shares you would only have to put up $ 2000.00. (The currency could be Pound Sterling or Euros, depending in which currency you have your account.)

If the price of the share rose by 10% you would have netted a $ 1000.00 profit, less dealing costs, while if you could have only purchased $ 2000.00 worth of shares you profit would be $ 200.00.

The risk is in the leverage, which could mean losing more money, if the trade goes against you. Understanding the risk you are taking on when you are trading any leveraged product is vital. Adhering to a strict position sizing strategy, not risking more than, 1% of your trading capital on any one trade is an elementary prerequisite to all types of margin trading.

Most traders and investors lose in the markets not because they get direction wrong, but because they fail to understand how to calculate risk correctly and manage their psychology. You may want to read more on the issue of risk here.

Advantages of CFD trading

In addition to being able to take advantage of leveraging your capital by trading on margin, for UK share dealings CFDs offer the advantage that no stamp duty is payable. If you are a trading more frequently and larger size this could amount to quite considerable savings over time.

CFDs can be traded in AUSTRALIA too. I like Australia, because it is a relative safe heaven today in my view, when compared to many other countries. The banking system is sound and the country’s economy is not plagued by the issues that are making Europe and America challenging to investors.

Diversifying your capital across several accounts in several countries is a sensible insurance policy against unexpected moves in currencies, or political risk. I have discussed the issue in an article for ADVFN, which you can read here.

CFDs give you flexibility: You have greater control over position size, as unlike most futures contracts, which have a high contract value per contract, you can trade much smaller size with a CFD. This will be particularly attractive to investors who are feeling their way into more frequent trading, wanting to diversify across different markets, for example, trading indices of different countries.

In summing up: CFDs are a viable trading instrument which gives you access to trading indices, stock indexes and shares, commodities and more flexibility with regard to position sizing.

Spreadbetting

Spreadbetting is a form of derivatives trading unique to the UK market since it is tax free for UK residents.

Opening a spreadbetting account with a sound, trusted broker enables you to trade stocks and shares and indices from many different countries. You can also trade FX pairs, indices, and commodities.

Spread betting the financial markets is similar to sports betting: You bet a fixed amount of money on the direction of an underlying.

For example, if you expect the S & P to go up by 20 points you can “buy”,(go long)  the S & P for, say £ 5.00 per point movement. If the price goes up by 20 points you sell, (go short) the S & P by £ 5.00, thus closing out the position. You will have made a profit of £5.00 X 20. The profit would be £ 100.00, less the cost of the spread, (dealing costs).

Typically, spread betting accounts don’t incur trade commissions, since dealing costs are covered through the spread.

Advantages of spreadbetting

The fact that spread betting is tax free to UK residents and that you can leverage your capital makes spread betting a very attractive trading alternative to conventional share trading which requires much more capital and is taxable.

As with all leveraged products you must adhere to a strict stop loss policy as your losses can potentially exceed your capital.

Spreadbetting is a great way to learn to trade at a relatively low cost, since you can place a bet with as little as £ 1.00 and open a trading account with a minimum of £ 500.00. The obvious tax advantages make this form of trading attractive too. Spreadbetting isn’t the cheapest form of trading, alas especially if you are in a higher tax bracket, it can make financial sense.