Review of Online Trading in Shares and cfds

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CFDs are derivative instruments designed to track movements in specific underlying financial instruments such as individual shares, so in trading them you do not actually own the physical assets upon which they are based. The main downside to not actually owning the underlying instrument is the exclusion from some of the rights enjoyed by those investors who choose to own the actual physical stock. In this respect, contracts for differences share the key characteristics of spread bets.

How do contract for differences differ from spread bets?

As mentioned above, both spread bets and contracts for differences are derivative instruments that allow investors to play both the long and short side of the market. This means that they share several features, some of which are discussed in more detail in the section below describing the key beneficial features of CFD trading.

However, while CFDs and spread bets are similar products, there are a number of differences that arise as a result of the differences in the way they are treated by regulatory and the tax authorities. These differences are explained further below:

Rules on investment advice: current financial regulation does not allow brokers to give advice on spread betting. This has a number of implications. One important one is that it means that spread bets are likely to remain firmly within the execution-only environment while brokers are able to give advice on CFD trades. Furthermore, unlike spread bets, contracts for differences are allowed in self-invested personal pension schemes (SIPPs). This arguably follows from the view that spread betting is highly speculative and unlikely to feature in a long-term investment plan.

Liability for CGT: unlike with spread bets which are currently free from capital gains tax, any profits made on trading in contracts for differences is liable to CGT. Experts believe the combined effect of restrictions imposed by the rules on investment advice and the variation in tax treatment would be that CFDs would be used increasingly as advisory and discretionary trading products, with brokers being able to charge more as part of a discretionary or advisory service.

Given the tax-free nature of spreads trading, most spread-betters are reluctant to switch to any product that makes them liable to capital gains tax. However, you should remember that trading can and do result in losses (as well as profits). Being liable for CGT also implies that you may be able to offset losses on CFD positions against profits elsewhere when it comes to computing overall capital gains for tax purposes.

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