Indices Trading
Trading Instruments
Indices Trading
Indices, measurements of price performance
Why Are Indices So Popular and How You Can Use That To Your Advantage
Trading novices always ask about measurements. They want precise numbers that will determine the outcome of their trades. Some are interested in specific instruments and measurements, while others want to get the numbers for the whole industry. Well, thanks to indices and indices trading, their wishes can become a reality.
How to Start
What Are Indices?
In short, indices are whole-sector tools that make indices trading especially appealing. They are an assortment of instruments and stocks that traders use to track industry growth or sector trajectory. On a micro-level, indices are measurements of price performance. If we know how a price (or any other piece of the market) is performing, we’ll know where our investment opportunities lie. So, to make a long story short — indices are tools that show us both fluctuations and opportunities.
Stock Indices in Financial Markets
Stock index, which is a statistical measure, tracks specific stocks that are traded publicly. When we follow that index, we can see how the market moves and make some investment decisions accordingly. A stock index will always track selected or somewhat related stocks.
There are broad and specialized indices. Broad ones reflect the cumulative value of an entire market, while specific ones are more narrow and cover industries or sectors (such as the financial sector). Both are equally important for indices trading.
The price of the stock index indicates how that specific stock bundle performs. If the stocks go up in value, the index’s price will increase (even if there are particular stocks in the pile that haven’t performed as well). It’s all about the majority.
While you can buy stocks directly, you can’t do that with indices. Instead, you can buy an index fund or stock index CFDs.
Index funds are the most affordable option among all fund variations. Stock index CFDs include speculating on the price change. That means traders can make a profit no matter which way the price change goes, which makes CFDs appealing to traders. What’s more, unlike individual stock CFDs, indices CFDs are not susceptible to significant changes due to individual factors (such as a PR scandal or a failed product launch). Instead, indices CFDs are collectives of stock from various companies, which means that a trader moves alongside losses and gains of major companies (as in, more than one). That makes them less volatile.
How are Stock Market Indices Calculated?
There are several different methods in indices trading for calculating stock market indices. The market capitalization-weighted method and the price-weighted method are the most popular and well-known ones. However, they aren’t the only ones.
The Market Capitalization-Weighted Method
Although there are some indices that are price-weighted (which means the changes in large share companies in the stock bundle have a more significant effect on the index price), we can typically calculate indices according to the market capitalization. In other words, the large companies that have a more significant market share influence the stock market indices more than other, lower cap companies.
The Price-Weighted Method
As mentioned, this method of calculating stock market indices involves giving more weight and influence to companies within the stock bundle that have a high stock price.
The Fundamental-Weighted Method
Finally, there’s the fundamentally weighted method that weights the index by appraising the size and influence of the company based on various factors (dividends, revenues, book value, and cash flow, for example). So this index will reflect the relative economic size of each stock compared to the entire bundle.
The Fundamental-Weighted Method
Finally, there’s the fundamentally weighted method that weights the index by appraising the size and influence of the company based on various factors (dividends, revenues, book value, and cash flow, for example). So this index will reflect the relative economic size of each stock compared to the entire bundle.
What Are Some of the Most Traded Indices?
The FTSE 100
As mentioned, this method of calculating stock market indices involves giving more weight and influence to companies within the stock bundle that have a high stock price.
Dow Jones
The second oldest US market is often referred to as simply Wall Street. It has 30 constituents which are some of the US’ biggest publicly owned companies. These companies are often referred to as blue-chip companies, and all of them are well-known. It aims to reflect the US economy, which is why almost all industries are equally represented.
The DAX
The 30 major German companies that trade on the Frankfurt Stock Exchange are sometimes called the Germany 30. The DAX holds around 75% of the Frankfurt Stock Exchange, which makes it a good indicator of Germany’s broad economy. More volatile than the UK and US markets, the DAX is ideal for CFD tradings.
NASDAQ 100
103 equities that are listed by the 100 top tech companies on the US NASDAQ stock exchange are known as the NASDAQ 100. These are market capitalization-weighted indices that are extremely volatile (due to the nature of the tech industry).
Nikkei 225
Nikkei 225 is a Tokyo Stock Exchange price-weighted index that measures the performance of 225 Japanese companies.
CAC 40
The French Stock Exchange index is often referred to as the France 40 since it comprises 40 of the biggest companies by capitalization on the French market. This is the benchmark equity index that’s quite similar to the Dow Jones index.
S&P 500 (US 500)
An index based on the market capitalization of 500 large-cap companies in the US is the S&P 500, which is one of the highest traded indices. Many traders consider the S&P 500 to be a good indicator of how both the stock market and the US economy will perform. This is the most diverse market.
What Moves the Index’s Price?
Even though we now know what indices are, we still can’t go into indices trading without knowing what moves the index’s price. There are a lot of factors that can move the price of an index in any direction. The most notable ones are:
- Economic news and data — both minor and significant economic changes, news, and developments will influence the market’s volatility which will, in turn, make the index price go up or down.
- Politics — political changes, especially in major economies (such as elections or passing of important bills that affect various markets), will be reflected in the index price.
- Company financial results — the financial gains or losses of a particular company that influence the share prices can affect the index price for the entire bundle.
- Company announcements — significant internal changes such as mergers with other companies or changes in the establishment will affect the share price.
- Changes to an index’s composition — if a new company is added to an indices bundle (or when one is removed), the index price will shift.
- Commodity prices — indices that have stocks of companies that deal with commodities will, of course, reflect the general prosperity of those companies. So, any major change in the commodity market will influence the price.
Why
Why go for Indices Trading?
We often hear people ask why even go into indices trading. Although nothing is guaranteed, indices trading has several specific benefits that make it appealing both to novice traders and to veterans.
Hedge Your Existing Positions
— If you have a bundle of different shares and want to protect yourself from losses, you might short an index. The short position will increase in value should the shares go down, and that will offset your initial losses. But if the shares go up, you might find yourself losing a part of the profits. However, with indices trading, if your shares are a part of an index and you go short on them, you could hedge your position against the risk and go long. That way, if the index rises, you’ll earn a profit to make up for your short position.High Liquidity
— Indices are more liquid than individual stocks. You can move more quickly with indices trading, which means that even interday trades are a real possibility.Broaden Trading Opportunities
— There are significant stock-specific risks that go with individual stock trading. Those risks might be stopping you from exploring the opportunities a sector or even an entire market has to offer. With indices trading, you don’t have to limit yourself.
High Volatility
— As mentioned, indices have high volatility. Volatility is an indicator of how fast the prices on the market change. Those changes are what traders take advantage of to make a profit. High volatility means that the price will move with less noise (in other words, with more conviction). That makes the price movement easier to predict. Less noise means fewer fake signals that result in profit loss (due to stop-losses hits).You Can Go Long or Short
— Because traders can bet on the price of the index going both up and down, there are more investment opportunities with indices trading. You can go both long and short and capture the movement of the market no matter what it actually is.Trade With Leverage
— When you trade with leverage, you only need the margin (a small deposit) in order to open the position. This provides you with a massive market exposure you otherwise wouldn’t have access to. Indices CFDs are leveraged products so, if you opt for indices trading, you can trade with leverage.How to Trade Indices Using CFDs?
Overall, indices trading isn’t complicated as long as you follow a few steps.
Find the Index You Are Comfortable With
As we mentioned already, there are indices from various markets. The US and the UK market are the most popular ones, but the Asian, Australian, and European markets are also available. If you have any prior knowledge of any stock index or the stock market, then it would be wise to go for that particular market.
However, even without prior experience, you can still trade, but you’ll have to do your due diligence. Research the factors we already listed that could potentially influence the stock index you’re interested in. At the end of the day, it’s essential that you go for the index you’re comfortable with.
Cash Indices or Index Futures?
You can get exposure to an index’s price with cash indices and with index futures. Which one you pick depends on whether you have short or long-term profit goals.
Cash indices are ideal for those looking for short-term trading opportunities. If you’re a day trader, this might be the right option for you. Cash indices have tighter spreads, and you trade them at the spot price. You can close a position before the end of the day and open a new one tomorrow, which makes cash indices especially appealing.
On the other hand, index futures are ideal for those looking for long-term opportunities. If you have a long-term market outlook, index futures will be more your speed given that you can trade at the futures price (the price that the traders agree on for future deliveries). Index futures have overnight funding charges covered, which is perfect if you’re looking to hold your position for longer than a day.
Decide Whether You Will Go Long or Short (Bearish or Bullish)
Logic dictates that after you’ve done your research and picked a market, you need to pick a direction. As mentioned, indices trading allows you to go both short and long, so you can pick the Bullish approach and buy or the Bearish approach and sell.Place Your Indices Trade
Next, you’ll need to actually place your trade. Don’t go over your budget when it comes to the size of the trade. If you bite more than you can chew in order to chase a profit, you might find yourself with nothing.
Do whatever you can to protect yourself from losses. We mentioned the high volatility as a benefit of indices trading. However, it can also be harmful to you if you don’t prepare correctly. So, take advantage of risk management tools at your disposal and protect yourself from major market changes.
Monitor and Know When to Close Trades
Knowing when to close a trade is half of the success (at least in indices trading). You need to stay on top of market movement, and you can only do that by monitoring your position and closing it on time. This is like a trading Goldilocks situation — not too soon, nor too late, but just on time.FAQs on Indices
What Exactly Are Indices in Trading?
All stock markets have major indices. These indices have one purpose — to report the performance of major stocks of companies quoted on that index. An index is a way of getting the general (and specific) idea about the overall market. The index gives you an indication of whether you’re in a bear or bull market. So, rather than trading individual stock, you can trade indices, which means you have exposure to every company quoted on that index.
But what are indices in trading? They are a financial instrument. If you take the values of all the companies quoted on an index, combine their assets, and get the average value, you’ll actually get an index value.
Why Should I Go for Index Trading Over Stock Trading? Is There Any Difference?
CFD trading uses indices trading. In other words, it sells or buys bundles of individual assets rather than individual stocks. CFDs are contracts that determine what the service providers and traders agreed on (for example, they can agree that if a price increases, the trader will get a specific profit, otherwise, they’ll lose their investment).
You can’t make those types of contracts with stock trading. If you buy individual stocks, in order to make a profit, the price has to increase. If it goes down, you’re losing money. CFD trading allows the trader to go both short and long, unlike individual stock trading.
What’s more, with individual stock trading, you have to actually buy the stock while the CFDs allow you to participate with a margin.
What Should I Know About the Index Economy? How Does It Work?
Indices are reflections of the value of individual assets. However, those assets are comprehensive. There are stocks, commodities, currencies, etc. Of course, stock indices are the most popular ones, and they are the benchmark indices. They reflect the movements in other markets rather than just their own.
So, if you want to get a glimpse of one country’s overall economy or a broader look at the world economy, all you have to do is look at indices. Successful companies drive both the economy and the index up in value. On the other hand, companies that experience great losses affect the indices negatively as they do the economy.
You can’t make those types of contracts with stock trading. If you buy individual stocks, in order to make a profit, the price has to increase. If it goes down, you’re losing money. CFD trading allows the trader to go both short and long, unlike individual stock trading.
What’s more, with individual stock trading, you have to actually buy the stock while the CFDs allow you to participate with a margin.
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