Is it better to trade forex or does the simplicity of spread betting make it the better option? Here we will look at the differences, advantages, and disadvantages of each approach. Ultimately you should choose the one that is best for you. Although as we will discover below, the differences between the two are subtle rather than dramatic.
What is Spot Forex Trading?
Spot forex is the sale or purchase of foreign currency that must be delivered immediately on the spot date, which is one or two business days after making the contract depending on which currency pairs are being traded. The spot forex market trades worldwide, with average trading volumes of $5 trillion a day. The exchange rate used for the transaction is called the spot exchange rate. You make a profit on the difference between the buying and selling rate.
With retail forex trading via an online broker standard transaction sizes are 100,000 base currency units. However, you can trade mini lots and micro-lots, which are respectively 10,000 and 1,000 base currency units. These lot sizes are expressed as 1.0 for a full single lot, 0.1 for a tenth, 0.01 for a hundredth and so on.
With spot forex trading, you can usually get relatively high leverage. Perhaps as high as 100:1 in some countries (although for UK-based brokers this tends to be lower at 30:1). In other words, if the leverage rate is 100:1 and you have £1,000 in your account, you can trade up to £100,000. Effectively this means you are speculating using borrowed money to fund your position. The main advantage is that you can profit from small changes in exchange rates. The downside, of course, is that you can equally amplify your losses.
What is Spot Forex vs Spread Betting
With financial spread betting, you do not exchange currencies as you would with spot trading. Instead, you take a position depending on whether you think a currency pair exchange rate will increase or decrease in the future.
Investors win or lose money depending on the variation and the expected value spread provided by the spread betting broker. The spread is essentially the difference between the bid and ask price, which is where the broker makes a profit. You bet on whether the price of the currency pair will be lower than the bid price or higher than the ask price.
Let us consider the EUR/USD pair. The brokerage quotes an ask price of 1.0015 and a bid price of 1.0010. If you think the euro will strengthen compared to the USD, you might bet €1 for each point the euro increases above 1.0015; in other words, a buy spread bet. For you bet to be profitable, the price must rise above 1.0015.
- Say that after a specific time, the EUR/USD reaches $1.0025, which is 10 points (pips) higher. In this case, you win € 1 x 10 = €10.
- But instead, if the euro happens to fall to $1.0005, which is 10 pips lower, then you would lose € 1 x 10 = €10.
If you think the euro will fall, then you bet selling short. In this case, your sell price is 1.0010. To make a profit, the ask price must fall to below that value. For each pip lower than that, you win € 1. Conversely, should the price rise, you would lose € 1 for each pip above the bid price of 1.0010.
In terms of leverage, just as with spot trading, you can use leverage.
Advantages and Disadvantages of Each Approach
OK, so now we understand the differences between spread betting and spot forex trading, let’s look at the relative advantages and disadvantages of both.
|Spread Betting||Spot Forex Trading|
|You are not charged capital gains tax on your winnings (in the UK).||Your profits are subject to capital gains tax (in the UK); however, you can offset your losses against your capital gains tax liability.|
|You do not pay a commission; you just need to cover the spread||You may be charged a commission on your trades though usually, you will pay the same spread as spot forex.|
|Banned in the USA||Allowed in the USA|
|Not permitted under Islamic law||Allowed under Islamic law|
Finally – Which is Best for You?
It depends on the circumstances. Not having to pay capital gains tax on spread betting gains in the UK is an attractive advantage. The spreads on both are similar, so in terms of commission, there is virtually no advantage or disadvantage. While some people might consider spot forex to be a more reputable form of investment and spread betting to be gambling, the argument is semantic; there is no real difference.
The contents of this website are intended for educational and information purposes only and do not constitute any form of advice or recommendation and are not intended to be relied upon by you in making (or refraining to make) any specific investment or other decisions. Appropriate expert independent advice should be obtained before making any such decision. We cannot and do not offer individual investment advice.