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Not An Accountant
I want to start by saying that I am not an accountant so don’t take anything here as tax advice… please. Thanks!
Tax? Dull, But Important!
People normally assume that if they are trading in the UK then they should be Spread Betting - after all, your profits are tax free, right? Yes, spread betting profits are tax free, but CFD or Forex trading profits can also be tax free up to a point.
It seems to be a widely believed myth that if you trade CFDs or Forex you will end up paying a massive chunk of your hard-won gains back out the door in tax. I thought I’d write this article to show that that is not always the case.
Spread Betting vs CFD Trading
For those that don’t know, the UK Government classifies Spread Betting as gambling, rather than trading. That means that any profits you make are viewed by the Taxman as gambling winnings, not investment income, and therefore there is no Capital Gains Tax (CGT) to pay on your profits.
With CFD trading or Forex trading you can be liable for CGT on your trading profits (nb. Forex, in the UK at least, is usually just a different way of labelling currencies CFDs). As a result, most UK traders Spread Bet, even if that limits some of their other options. Capital Gains Tax can be 10% or even 18%, and you’d have to have a pretty good reason to trade CFDs instead of Spread Betting to give away 18% of your profit!
But, a lot of traders I have spoken to seem to have forgotten that CGT only kicks in once you have hit a certain threshold of gains. As of April 2017 that threshold is £11,300 per year. How many new, or smaller account traders can actually claim to be making over £11,300 a year in gains?
The average UK depositor puts down about £3000 when they open an account. But even if you have a much larger account, say £10,000, £20,000 or even £50,000 you may still not have to worry about CGT. If you make a very respectable 20% on a £50,000 account you still won’t actually hit the threshold!
It is worth noting that if you hold other investments, such as a shares portfolio, then profits on that may well contribute to that CGT threshold, so do be careful. As I said, I’m not an accountant; do your own research and speak to a qualified accountant!
As you can see, unless you are in the fortunate position of expecting more than £11,300 of gains on your trading in any given tax year, trading CFDs is actually open to you as an option without taking a tax penalty when compared to Spread Betting.
So What are the Benefits of CFDs?
I have given you a reason why there’s no harm in you trading CFDs instead of Spread Betting (if you won’t hit the threshold), but now here are a couple of reasons you may consider CFDs actually being superior to Spread Betting.
You can trade a far smaller trade size in CFD trading. The minimum trade size in spread betting is £0.25 per pip, often £0.50 or even £1.00 per pip depending on the product and your broker.
CFD Trading
This means on a trade with a typical 50 pip stop loss you could be risking £50 minimum with no option for a smaller trade size.
Given that it is usually recommended that good risk management would see you risk a maximum of 1% of your account on a trade, this might be tricky when spreadbetting. If you have to risk £50 then you’d have to have at least a £5000 account, which many people do not.
However, with a CFD account you can usually trade a far smaller amount. With CMC Markets , for instance, you can literally trade a $1 CFD contract, but the minimum contract on GBP/USD when Spread Betting is £0.50 per pip. Given the tiny average daily percentage move in currencies, you can basically risk about 1p at a time on CFDs if you choose!
Given that a lot of people are opening £200 or £300 accounts, risking £25 or £50 a time may not be ideal - so forget Spread Betting and open a CFD account!
It is Easier to Find an STP or ECN CFD Broker if you know what these terms mean then there is a chance that you will be looking to trade with a broker that passes your trades straight into the market, rather than acting as a market maker with you.
If so, your options are extremely limited if you want to Spread Bet, but with CFD trading you have dozens of options. If it is important to you that you are not in a position where you may end up "trading against your broker" then you will probably want to look at CFD trading.
Do I Recommend Everyone Switches to CFDs?
No, not at all. If you are Spread Betting currently and like your broker and aren’t worried about the trade size, then you should keep doing what you are doing. "If it ain’t broke, don’t fix it", and all that.
Equally, if your nickname is Moneybags and you have a £100,000 account or your nickname is Gordon Gekko and you reckon you’ll do 200% on your £10,000 account this year, then maybe don’t change - you’ll probably end up with a hefty CGT bill!
But if you are just getting into trading and have less than about £5000, then you may want to consider CFDs over Spread Betting so you can trade small to start out with. Or if you are planning on swing trading with large stop losses then the ability to take a smaller position size may benefit you. Or maybe you just prefer a CFD broker and want someone to tell you that it is OK to trade CFDs and not Spread Bet!
If you are new to trading you may want to consider going with a broker who offer both CFD and Spread Betting accounts, then you can mix it up and experiment, or indeed, switch from CFDs to Spread Betting once you hit the CGT tax threshold!
Whatever you decide to do, I suppose I just wanted to expose a myth and point out to UK traders that Spread Betting isn’t the only game in town.
Happy Trading
About the Author
Owen - Two Blokes Trading
Two Blokes Trading is a fun and informative trading podcast and website for new and experienced online traders.
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