Forex trading and spread betting may sound similar, but they are actually very different. Find out what distinguishes the two and which one is better for you.
Every day, a huge number of new traders start trading for their very first time on the forex market. More often than not, they are simply attracted by the prospect of getting easy and quick profits, so they just dive in straight away without first educating themselves on how the system works. This is a rather crucial mistake that beginners often make. Therefore, the best way to approach the market is to get at least the basic education first before jumping in.
If you just started to learn about financial marketplaces and trading assets, you might find yourself overwhelmed by the sheer range of trading options and tools available to traders. The number has grown especially in the last decade, following the rapid development of technology and the emergence of online brokerage firms.
Naturally, these firms often compete with each other by creating new opportunities and trading conditions in order to attract new clients. As a result, you will find that the chance of making profits doesn't stop at forex trading only. Some brokers also offer spread betting, which is pretty popular in certain countries.
While it's great that forex brokers have put some effort to create more opportunities for traders, they have also caused some confusion among traders who haven't got any clue on what to do with their capital yet. So today, we're going to talk about the main differences that distinguish forex trading and spread betting, along with the pros and cons of choosing each one.
What is Forex Trading?
Forex trading is one of the most popular investment methods in the world. It's quite unsurprising since the forex market is known as the largest financial market, very liquid, and runs 24 hours a day. Essentially, forex trading is similar to buying and selling other tradable assets like stocks. The main difference is that forex trading uses currency pairs like EUR/USD or JPY/GBP.
In simpler terms, forex trading is the act of selling one currency and buying another in an exchange, as per the existing exchange rate between the two currencies.
So for example, let's say the exchange rate of Euro and US dollar is 1.40 to 1. That means, if you buy 1,000 euros, then you need to pay 1,400 US dollars. If the price rises and the exchange rate later changes to 1.50 to 1, then you can make a profit by selling the euros for 1,500 USD, generating a profit of 100 USD. In other words, you will get profit if the currency you buy moves up against the currency you sell. The profit is simply the difference between the buying and selling prices.
Since the practice of forex trading has been long established in the financial industry, forex trading has the benefit of higher regulation. Forex trading is often provided by reliable brokerages or financial institutions like banks, so it is relatively safer for traders. It is also more accessible compared to other investments because all major brokers support it.
Apart from that, the forex market has high liquidity on major currency pairs, hence there's a higher chance of getting profit if you know how to do it properly.
On the other hand, the biggest drawback is that forex trading is not free of tax, so you may have to pay for tax in each transaction. Also when it comes to the actual trading, some slippage and requotes might occur depending on your broker.
What is Spread Betting?
In spread betting, you don't use an exchange of the currency and there's no need to purchase the asset that we're going to trade. Instead, spread betting involves making a simple wager based on anticipating whether the price of the asset will rise or fall in the future.
The term "betting' actually means that the investor will either gain or lose money based on the marginal variation of a specific outcome and the expected value spread quoted by the spread betting broker. Not only forex, but you can also do spread betting for various other assets such as interest rates, individual share prices, commodities, indices, etc. Depending on the trader's prediction of the market movement, you can either open a long buy position (if you expect the price to rise) or a short sell position (if you expect the price to fall). Don't forget to use our tool to make calculations easier.
What's great about it is that in contrast to forex trading, spread betting is not subject to any tax and has no slippage.
However, since spread betting was introduced more recently, its availability is still limited to certain countries only. It's also worth mentioning that spread betting usually involves the use of high leverage, so the risk of potential loss is relatively higher compared to forex trading.
Similarities of Forex Trading and Spread Betting
Forex trading and spread betting are certainly not the same, but there are several notable similarities that you should know. First of all, in both forex trading and spread betting, you can either go long or short with the asset. This means you can take profit in any type of market, whether it's rising or falling.
In spread betting, the trader should predict whether they think the market will rise or fall, so it doesn't matter where the market is going as long as it matches with the trader's prediction. Similarly, in forex trading, traders can take profit in any situation, depending on whether they choose to buy or sell the asset.
Another similarity is that you can use leverage on both forex trading and spread betting. Using leverage means that with just a small amount of money, you can increase the size of your position with the leverage or the borrowed money. The amount depends on your broker's policy. For brokers that are regulated by ASIC, FCA, and ESMA, the maximum leverage for forex trading is 30:1. Under FCA, the maximum leverage for spread betting is also 30:1.
Differences between Forex Trading and Spread Betting
Because some of the characteristics, forex trading and spread betting could be similar, but actually they are two contrasting ideas. Find out about few of the important differences between them:
1. Tax on Profit
Even though you can forex trading profits can be tax-free in certain countries, typically, when dealing with any form of financial speculation investment, investors have to pay tax on their profits. Regardless of how small the amount of tax is on each transaction, it will eventually add up and the trader might find a pretty large sum by the end of the year.
Spread betting, however, is a little different because the trader doesn't have to purchase the asset. Instead, they only place a simple bet of where the market is going to move. Since there's no physical sale on the asset, spread betting is free of Capital Gain Tax and Stamp Duty under UK law, so the trader can keep 100% of the profit that they've made.
2. Markets Used
As the name suggests, forex trading involves the use of foreign currency, so it can only be done in the forex market. It's a highly liquid and profitable market, but it's quite limited in terms of assets, segments, and derivatives available for traders.
Meanwhile, in spread betting, the scope is broader because traders can choose to use a wide range of assets beyond only currencies. Depending on the brokerage firm, you might be able to use various financial instruments such as indices, stocks, commodities, and more to do spread betting. Therefore, there's a higher chance to diversify one's portfolio and optimize the profitability of the trade.
Forex trading has been around for a longer time, so forex is already widely known and accessible from practically anywhere in the world. On the other hand, spread betting is only available in certain countries at the moment. This depends on the broker, but mostly it is acceptable in the UK, Ireland, Taiwan, Hong Kong, and several other areas. The option is still very limited due to the high-risk nature of this kind of betting and the association with gambling.
4. Compliance with the Islamic Law
Spread betting is mostly seen as a form of gambling, which is clearly not acceptable under Muslim laws. Thus, it's mostly banned in Islamic countries. Meanwhile, it's possible to do forex trading in Islamic law countries, but you need to open a special Islamic account to proceed. So if you're in an Islamic country and you want to try forex trading, you can simply search for brokers that offer swap-free Islamic accounts.
Which One to Choose?
Ultimately, the choice of which investment method is better depends on your personal preference. Many factors should be considered in your decision, including your trading style, strategy, and precise goals as an investor. We've learned that each option has its own pros and cons, so what's important is choosing the one that fits you the most.
Overall, it's worth noting that the main advantage of forex trading is its accessibility. Forex trading is available to most brokerage firms and countries, so it's great for beginners who just started their trading journey.
Especially now that there are various products and tools offered by forex brokers to help new traders navigate their way around and make forex trading easier. Forex trading is also in compliance with Islamic law, so it's definitely the better choice for Muslim traders. On the other hand, spread betting has more of a financial benefit, since it's free of Capital Gains and Stamp Duty taxes under UK law.
Whatever your choice, the most important thing is to entrust your financial activities to the right and reliable broker, particularly as a beginner in the industry.