What does Spread mean in CFD trading Complete guide

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What is a Spread? – Spreads Explained for CFD Trading

Updated on: 6 January 2020

The road to financial trading is filled with obstacles and if you are to become at least half as good as you hope to be, you have a lot of information to deal with. Notions like margin, leverage, breakeven price, spread and everything in between serve as the foundation for understanding how the trading sector functions.

So, today we are going to talk about the spread and what exactly makes it such an important concept for any trader, regardless of his experience. In the financial industry, the spread represents the difference of value between the buy price and the sell price and it is applicable to any type of asset or goods being transacted.

An incursion into the basics of financial trading

Let’s take an example of that, so it will be easier to understand:

In financial terms, the spread is the difference between the bid and the ask price. In this case, we have an asset positioned under the 2 main tags – SELL and BUY. The BUY is the bid price and the SELL is the ask price. These are the 2 options you, as a trader, can operate under.

What you will notice is that the asset’s SELL tag displays 5,589.4, whereas the BUY tag displays 5,590.4. Here, as you can probably see, the spread equals to 1.0, because that is the difference between the SELL and BUY. This value will constantly vary depending on a number of factors, but the principle remains the same, which is: there will always be a difference between the ask and the bid price you can exploit.

Now, there are several aspects you need to take into account when talking about the spread:

– The buy price will always be higher than the sell price – If it would have been the other way around, nobody would have bought anything, ever, because the profit would have been all gone. You can see that when you are trading currency. The BUY and SELL options will always differ by the fact that the BUY option will always hold the higher value.

It is how both brokers and traders make profit, as long as they get to take advantage of the spread (the difference between BUY and SELL) and create profit.

– A tight spread makes room for larger profits – It is one of the basics of spread. Think about it logically. If you are able to buy for almost the same price you could sell it for, making profit would be extremely easy, because you will have more room to add financial value to the asset before selling it.

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On the other side, if the spread gap is too large, you probably won’t have any profit margin at all. You can’t buy extremely high and sell it for an extensively higher value.

– The value of the spread is dictated by the number of market participants – This is a good thing, because it gives you the opportunity to develop specific strategies to increase your chances of making profit. What is more important to keep in mind is that the more participants take part in transacting a certain asset, the tighter the spread of that particular asset becomes.

The reverse is that the spread loosens up when the number of traders decreases.

– The value of the spread is also dictated by major market events – They don’t even have to be major, because anything that happens on the market, no matter how small and petty might seem, will send ripples through it. The only thing that differs is the intensity.

This means that having a solid grasp of what is going on in the economic and financial spheres is one of the must-dos if you are to either avoid unpleasant surprises or take advantage of the pleasant ones.

Is it necessary to know all these facts? Absolutely. I would even go one step further and claim it is imperative. I have seen a lot of people, at one point successful traders, who have almost been ruined by not paying attention to the spread and investing more than they should have.

Which goes to show keeping your eye on the spread is important from two perspectives: it helps defining your profits and it can help you save your money or cut the losses, when things go south.

The benefits of spread betting

There is an important thing we need to mention before jumping to the actual benefits. Spread betting is illegal in the US. Not illegal in the UK, though, so, if you are interested in this form of trading, you know what you have to do. By any means, refrain from resorting to any practices that are against the law. It will never end well for you.

With that being said, here are some actual advantages of taking on spread betting:

1. You are trading on a margin

You know how the margin functions, right? You only need to bid a certain percentage of the asset’s value, instead of buying the asset entirely. This translates by lower investments and higher payouts.

2. The market is open 24 hours per day

This means you are not limited by specific timeframes, which is something you won’t find on the traditional markets.

3. The profits are tax-free

Unlike buying and selling shares, for instance, this time you are not requested to pay any type of capital gains taxes on your raw profits. At the same time, you are not required to pay any commissions either, since they are already included by the spread bid.

4. Multiplying your gains with the help of leverage

The leverage lets you bid based on a percentage of the asset’s value (which represents the margin). In other words, you can open and maintain a position with only a fraction of what that position would require your deposit to be. Needless to say, your gains will increase exponentially when the market moves in your favor, while your financial efforts are minimum.

5. Using short positions

It doesn’t matter where the market heads. One of the main spread betting benefits is that you make money from both rising and falling markets. It is all up to how you decide to play your cards.

In theory, everything seems easy enough. If everything goes well, you should be able to hit it big with no problem. But we both know that is now how things function. As a result, you have a lot of things you need to be cautious about. Some which you can control, some which you can’t.

The risks of spread betting

Like I said, there are some risks, the majority of them, that you can actually prevent for the most part. Other, unfortunately, will be completely out of your control, an aspect that lays at the very foundation of the trading business as a whole. Because, as you may know, the first lesson of trading is you can’t control the outcome 100%.
So, we are going to take these risks one by one and see what you should expect when going into the business.

1. Avoid shady brokers

One of the main problems most people find themselves buried in is that they get ripped by their own brokers. Some resort to spread manipulation without their consent, leading to the brokers increasing their profits, while their clients take the losses.

Your best course of action would be to only select those brokers with a pristine reputation and recommendations. Trust me, there are more dirty brokers out there than there are honest ones. As a result, you need to know what to look for.

2. The leverage

Yes, the leverage can get you a lot of money. The problem is it can take it away with the same ease. Not to mention that, in reality, the leverage can make you lose money you don’t have, as your account will fall to negative literally overnight. This is why you see people ending up owing ten times more than they have invested in a matter of days and it is all because of how the leverage works.

3. Look for the cheapest provider

I believe this one is a common sense advice. Pretty sure you didn’t actually need it. What you do need to know, though, is that not all brokers include their brokerage fees in the value of the spread bet. As a result, you may experience additional costs during the trading.

4. The market is volatile

But, then again, the market functions the same regardless of the type of trading you are focusing on. So, in this regard, it is your primary job to elaborate risk management strategies, mainly involving keeping the market under strict surveillance. This is among the best ways of preventing unwanted surprises.

Is spread betting worth it?

At the end of the day, I guess this is where we draw the line. After all, what truly matters is being aware of the risks and knowing what strategies to adopt to minimize them as much as possible. You may have noticed I said nothing about knowing the benefits. That is because, once you can protect yourself from the risks, the benefits will come on their own. You don’t need to summon them.

So, is spread betting worth risking your money? Let me start with the conclusion: yes. And here is why:

– You can choose when to make more money – If you have read this article carefully, you know by now that the most advantageous situation for you is when the spread is tight, right? What does that tell you? It is pretty simple: only start trading when the market is at its peak. The more traders buy and sell and create a competitive environment, the tighter one asset’s spread will become. Which equals larger profits.

– Only trade main currencies – This is closely related to the first point. The main currencies are those that attract all the focus. This will narrow the spread value as a result. If you want to go for secondary currencies (in the sense of their importance on the market), they will automatically offer a wider spread and, thus, less profit.

– Learn when or when not to risk – I agree, this one tip focuses on experienced traders, those who already know what they are doing. But it doesn’t hurt to keep it in mind as a beginner as well. If you are like me and work hard, learn and adapt fast, you will probably develop a certain risk sense, knowing when a trade is worth it and when it isn’t.

My last advice would be this. Learn all about financial spreads. Learn and improve your game and, most importantly, never lose sight of your goals and don’t lose focus. In this industry, what comes around goes around.

And your main focus should be on making it come around more often.

What is a spread?

In CFD trading, the spread is the difference between the buy price and the sell price quoted for an instrument. The buy price quoted will always be higher than the sell price quoted, and the underlying market price will generally be in the middle of the these two prices. ​​

When you place a trade, you will either buy or sell the particular product you’re trading, depending on whether you believe the underlying market price will rise or fall.

Once your trade is placed and the price has moved in your favour beyond the cost of the spread, it will be a profit making trade. Likewise, while it remains between the spread range or outside of it against you, the trade will be a losing trade.

The spread is one of the key costs involved in CFD trading – the tighter the spread is, the better value you’re getting as a trader. Note that there are other potential costs to consider, for example in CFD trading some markets involve a commission charge, or a combination of spread and commission.

The spread is the last large number within a price quote.​

Example 1

The spread on the UK 100 shown here is 1.0, calculated by subtracting 6446.7 (sell price) from 6447.7 (buy price).

Example 2

The spread on the GBP/USD shown here is 0.9. If you subtract 1.65364 from 1.65373, that equals 0.00009, but as the spread is based on the last large number in the price quote, it equates to a spread of 0.9.

We offer competitive spreads across our wide range of markets, which helps to reduce the overall cost of trading.

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Investing in CMC Markets derivative products carries significant risks and is not suitable for all investors. You could lose more than your deposits. You do not own, or have any interest in, the underlying assets. We recommend that you seek independent advice and ensure you fully understand the risks involved before trading. Spreads may widen dependent on liquidity and market volatility.

The information on this website is prepared without considering your objectives, financial situation or needs.

What is a spread?

In CFD trading, the spread is the difference between the buy price and the sell price quoted for an instrument. The buy price quoted will always be higher than the sell price quoted, and the underlying market price will generally be in the middle of the these two prices. ​​

When you place a trade, you will either buy or sell the particular product you’re trading, depending on whether you believe the underlying market price will rise or fall.

Once your trade is placed and the price has moved in your favour beyond the cost of the spread, it will be a profit making trade. Likewise, while it remains between the spread range or outside of it against you, the trade will be a losing trade.

The spread is one of the key costs involved in CFD trading – the tighter the spread is, the better value you’re getting as a trader. Note that there are other potential costs to consider, for example in CFD trading some markets involve a commission charge, or a combination of spread and commission.

The spread is the last large number within a price quote.​

Example 1

The spread on the UK 100 shown here is 1.0, calculated by subtracting 6446.7 (sell price) from 6447.7 (buy price).

Example 2

The spread on the GBP/USD shown here is 0.9. If you subtract 1.65364 from 1.65373, that equals 0.00009, but as the spread is based on the last large number in the price quote, it equates to a spread of 0.9.

We offer competitive spreads across our wide range of markets, which helps to reduce the overall cost of trading.

An Introduction To CFDs

The contract for difference (CFD) offers European traders and investors an opportunity to profit from price movement without owning the underlying asset. It’s a relatively simple security calculated by the asset’s movement between trade entry and exit, computing only the price change without consideration of the asset’s underlying value.   This is accomplished through a contract between client and broker, and does not utilize any stock, forex, commodity or futures exchange. Trading CFDs offer several major advantages that have increased the instruments’ enormous popularity in the past decade.

How a CFD Works

If a stock has an ask price of $25.26 and the trader buys 100 shares, the cost of the transaction is $2,526 plus commission and fees. This trade requires at least $1,263 in free cash at a traditional broker in a 50% margin account, while a CFD broker formerly required just a 5% margin, or $126.30. A CFD trade will show a loss equal to the size of the spread at the time of the transaction so, if the spread is 5 cents, the stock needs to gain 5 cents for the position to hit the breakeven price. You’ll see a 5-cent gain if you owned the stock outright but would have paid a commission and incurred a larger capital outlay.

If the stock rallies to a bid price of $25.76 in a traditional broker account, it can be sold for a $50 gain or $50/$1263 = 3.95% profit. However, when the national exchange reaches this price, the CFD bid price may only be $25.74. The CFD profit will be lower because the trader must exit at the bid price and the spread is larger than on the regular market. In this example, the CFD trader earns an estimated $48 or $48/$126.30 = 38% return on investment. The CFD broker may also require the trader to buy at a higher initial price, $25.28 for example. Even so, the $46 to $48 earned on the CFD trade denotes a net profit, while the $50 profit from owning the stock outright doesn’t include commissions or other fees, putting more money in the CFD trader’s pocket.

Getting Market Leverage: CFD versus Spread Betting

Brief Overview

Investments in financial markets can reap large rewards. However, traders cannot always access the capital necessary to get significant returns. Leveraged products offer investors the opportunity to get significant market exposure with a small initial deposit. Popular in the United Kingdom, contracts for difference (CFDs) and spread betting are leveraged products fundamental to the equity, forex and index markets.

Key Takeaways

  • Contracts for difference, or CFDs, are short-term leveraged derivative contracts that track the value of some underlying instrument and pay off accordingly.
  • Spread betting involves placing a speculative bet on the price movements of an underlying instrument without actually owning it.
  • Although similar on the surface, there are several fundamental nuances that differentiate CFDs from spread betting.

Contracts for difference, or CFDs, are derivative contracts between investors and financial institutions in which investors take a position on the future value of an asset. Similarly, spread betting allows investors to place money on whether the market will rise or fall. Differences in the settlement between the open and closing trade prices are cash-settled. There is no delivery of physical goods or securities with CFDs, but the contract itself has transferrable value while it is in force.The CFD is thus a tradable security established between a client and the broker, who are exchanging the difference in the initial price of the trade and its value when the trade is unwound or reversed.

Although CFDs allow investors to trade the price movements of futures, they are not futures contracts by themselves. CFDs do not have expiration dates containing preset prices but trade like other securities with buy and sell prices.

CFDs trade over-the-counter (OTC) through a network of brokers that organize the market demand and supply for CFDs and make prices accordingly.

For the most part, CFD trading is not allowed by law for American residents.

Spread Betting

Spread betting allows investors to speculate on the price movement of a wide variety of financial instruments, such as stocks, forex, commodities and fixed income securities. In other words, an investor makes a bet based on whether they think the market will rise or fall from the time their bet is accepted. They also get to choose how much they want to risk on their bet. It is promoted as a tax free, commission free activity that allows investors to speculate in both bull and bear markets. The bet itself is not transferrable to anybody else.

Spread-betting companies provide buy and sell prices to potential investors who position their investments with the buy price if they believe the market is going up or sell price if they believe the market is due to tumble. Spread Betting, unlike traditional investing, is actually a form of betting. Unlike fixed-odds betting, it does not require a specific event to happen. You can actually close in the bet at any time and take home the profits or limit the losses. FSB is a margined derivative product that allows you to bet on the price movements of all kinds of financial markets and products, such as stocks, bonds, indices and currencies, etc. An investor can get into long (similar to buying a share) or short (like selling a share) bets depending on the prediction or direction the market moves.

Similarities

CDFs and spread bets are leveraged derivative products whose values derive from an underlying asset. In these trades, the investor has no ownership of assets in the underlying market. When trading contract for differences, you are betting on whether the value of an underlying asset is going to rise or fall in the future. CFD providers negotiate contracts with choice of both long and short positions based on the underlying asset prices. Investors take a long position expecting the underlying asset will increase, while short selling refers to an expectation that the asset will decrease in value. In both scenarios, the investor expects to gain the difference between the closing value and the opening value.

Similarly, a spread is defined as the difference between the buy price and sell price quoted by the spread betting company. The underlying movement of the asset is measured in basis points with the option to purchase long or short positions.

Margin and Mitigating Risks

In both CFD trading and spread betting, initial margins are required as a preliminary deposit. Margin generally varies from .5 to 10% of the value of the open positions. For more volatile assets, investors can expect greater margin rates and for less risky assets, less margin. Even though the investors in both CFD trading and spread betting only contribute a small percent of the asset’s value, they are entitled to the same gains or losses as if they paid 100% of the value. However in both investment strategies, CFD providers or spread betting companies can call the investor at a later date for a second margin payment. (For more, see the tutorial: Margin Trading.)

Risk in investing can never be avoided. However it is the investor’s responsibility to make strategic decisions to avoid severe losses. In both CFD trading and spread betting the potential profits may be 100% equivalent to the underlying market, but so can potential losses. In both CFDs and spread bets, a stop loss order can be placed prior to contract initiation. A stop loss is a predetermined price that automatically close the contract when the price is met. To ensure providers close contracts, some CFD providers and spread betting companies offer guaranteed stop loss orders at a premium price. (For more, see: Narrow Your Range With Stop-Limit Orders.)

Main Differences

Spread bet, have fixed expiration dates when the bet is placed while CFD contracts have none. Likewise, spread betting is done over the counter (OTC) through a broker, while CFD trades can be completed directly within the market. Direct market access avoids some market pitfalls by allowing for transparency and simplicity of completing electronic trades.

Aside from margins, CFD trading requires the investor to pay commission charges and transaction fees to the provider; in contrast, spread betting companies do not take fees or commissions. When the contract is closed and profits or losses are realized, the investor is either owed money or owes money to the trading company. If profits are realized, the CFD trader will net profit of the closing position, less opening position and fees. Profits for spread bets will be the change in basis points multiplied by the dollar amount negotiated in the initial bet. Both CFDs and spread bets are subject to dividend payouts assuming a long position contract. While there is no direct ownership of the asset, a provider and spread betting company will pay dividends if the underlying asset does as well. When profits are realized for CFD trades, the investor is subject to capital gains tax while spread betting profits are tax free. (For more, see: Don’t Let Brokerage Fees Undermine Your Returns.)

The Bottom Line

With similar fundamentals on the surface, the nuanced difference between CFDs and spread bets may not be apparent to the new investor. Spread betting, unlike CFDs, is free of commission fees and profits are not subject to capital gains tax. Conversely, CFD losses are tax deductible and trades can be done through direct market access. With both strategies, real risks are apparent, and deciding which investment will maximize returns is up to the educated investor.

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