When it comes to investing in companies, the first port of call is often the stock market. A stock market is where different investors can buy and trade shares in listed companies with the hope of making a profit from dividends and rising prices.
Investing in companies through shares is just one of many ways to get involved with the market. You can also gain access through funds, investment trusts, enterprise investment schemes and venture capital trusts.
Buying shares is a relatively simple concept, you own a portion of a company and benefit if its share price rises and lose out if it falls. More adventurous traders can also get involved in the stock market through contracts for difference and spread betting. Traditional share investors may not have come across these products but essentially, rather than buying a share you are betting on price movements.
We explain what CFDs and spread betting are below.
Spread betters bet on the movement of a share price. This is a particularly good tool when markets are moving up and down as traders can take advantage of price movements.
You don’t buy the actual share, so there is no Stamp Duty or Capital Gains Tax to pay. The only dealing charge you pay is worked out as the difference between the buying and selling price, known as the spread. This is added to the cost of the trade.
CFD Trading platforms usually have a minimum you can bet based on the number of points you think a share will rise or fall.
A contract for difference is a form of a derivative or financial contract where traders agree to exchange the difference between agreed prices of an asset. Traders open a CFD on a trading platform and agree to either receive or pay the difference of the market price of a share over an agreed period.
You can bet on whether prices will rise or fall, but a trader will have to pay up if they make the wrong bet. Traders tend to use CFDs as a way of hedging to offset any loss in value in the portfolio. For example, if you hold £1,000 worth of shares in company x and think they are set for tough times, you could buy a CFD of the same value and are effectively short-selling that share.
If the share price does fall then you the CFD contract should make up the difference.
Spread betting and contracts for difference are both about making money from rising or falling markets. In both cases you don’t have to buy the actual shares. CFDs can be purchased on real assets such as shares while spread betting can encompass wider markets such as sporting events.
In the case of spread bets you are gambling on how the price will move while with a CFD, you are agreeing to buy at one price and sell at another. Spread bets have a fixed expiry while CFDs can be rolled over.
Charging structures are different, with charges on share CFDs attracting commission fees, which can be charged daily on long-term contracts. A spread bet has its charge loaded into the difference between the buy and sell price.
Spread betting is seen as gambling, which isn’t liable for capital gains tax. However, gains from CFDs will have a CGT charge, although you can offset losses against future profits. CFDs, unlike spread bets, also have currency risk if dealing with foreign shares .
Ultimately the route you use will probably come down to preference and the type of market you want to trade.
This article is produced by our partner at Discovermedia.co.uk.