Brokers offer access to some of the most traded stock indices globally such as the S&P 500, DJIA, NASDAQ 100, FTSE 100, the DAX 40 and many more. Indices trading refers to the activity of opening a position on a stock index which is a good indicator of the price performance of numerous different companies. For example, the FTSE includes the largest 100 qualifying UK companies by market value. Each company’s total market value is calculated by multiplying its share price by the total number of issued shares.
Trading indices with CFDs
Trading indices with CFDs has gained in popularity and is an efficient way to speculate on their price rising or falling without owning the underlying asset. Indices, like other popular financial markets, are a highly liquid market, and with many trading hours available to trade, traders can get more exposure to trading opportunities.
With more financial news available online, traders do not need to research for hours. By trading a basket of stocks, traders reduce risk as they avoid buying or selling individual company shares and instead trade an index, or a collection of stocks.
How do you trade indices?
There are a wide range of online brokers with competitive conditions that can offer access to trading indices. By registering with a broker, traders can use CFDs to trade indices. CFDs are financial derivatives which are used to speculate on indices and whether their price will go up or down.
CFD stands for contract for difference and refers to a contract between two parties to exchange the difference in price from when the contract was created to the point at which it was closed.
Traders can enjoy trading indices with CFDs which are accessible with an online broker by using a trading platfrom such as the MT4 on their mobile or desktop.
Which index to trade
Cash indices are very popular among day traders who want to trade in the near-term and see results. They prefer cash indices due to the fact that they have tighter spreads than index futures. Cash indices are traded at the spot price. Traders commonly close their cash indices positions at the end of the trading day and open new positions the following day so they avoid paying overnight charges for leaving their positions open.
Cash market transactions take place on regulated exchanges or over-the-counter (OTC). The NYSE is an example of a regulated cash market. The S&P 500 Index contains 500 of the largest stocks that trade on the New York Stock Exchange (NYSE).
Cash indices are a good way to monitor market trends and can be used to measure the price changes in the underlying market and provide a comprehensive view throughout the years. This is particularly helpful as traders can examine certain indices and understand how and why they react to economic trends over a period of time, so they can make informed trading decisions.
Traders with a long-term market outlook usually prefer index futures. These have bigger spreads, but the overnight funding charge is included. Index futures are traded at the futures price which means a price is agreed in the present to be delivered in the future.
Traders who trade index futures and open an index position over the long-term do not have to pay regular overnight funding charges.
Opening an account to trade indices
To start trading indices with CFDs today, you need to first open an account with a reliable and recognised broker. Then you need to choose an index you are interested in and suits your trading style and risk appetite. You also need to consider whether you will open short-term or long-term positions and how much capital you want to trade with.
Some traders with high risk appetite tend to prefer a more volatile index such as the DAX 40, while more conservative traders will tend to choose an equity index such as The Standard and Poor’s 500, which is popular among long-term traders for its steady returns over a period of time.
Trading indices your way
While you can access various indices and potential opportunities from a wide range of markets with a reliable broker, you still have to choose your trading style and how you want to allocate your funds.
As a trader, you get to decide whether to go long or short. If you go long, it means you are speculating on the value of an index increasing, and if you go short, it means that you are speculating on its value falling.
Also, if the outlook for a country’s economy seems healthy and strong based on the performance of the companies on an index, then opening a long position could help you realise a potential profit if the index’s value increased. On the other hand, if market sentiment is weak and the economic look seems gloomy, possibly because the larger companies of the index are not performing well, then you might choose to go short as you will be speculating that the index could potentially fall in value.
When trading, risk management is one of the necessary tools to protect your funds and limit potential losses in the event that a trade doesn’t go as expected. Stop and limit orders are some of the significant tools that traders can choose to manage their risk while trading indices.
A stop order means that your position will close automatically if it goes to a less favourable level than the current market price, while a limit order will close your position automatically if the price rises.
Placing a trade
When you’re ready to start indices trading, you can open your trade. First you choose the market you want to trade on MT4 and then you choose a cash price or a future price. If you buy, then you are speculating that the price will go up, but if you are selling then you speculate on the price of your asset going down. Enter the size of your position and place your trade. You can monitor and close your trade whenever you like. If you believe you can take a profit or want to cut any potential losses then you can close your trade.
What are examples of indices in trading?
The NASDAQ–100, S&P 500, Hang Seng, FTSE 100 and DIJA are some of the top indices. According to the Index Industry Association, there are 3.05 million stock market indices around the world including large company indices to smaller ones such as industry sub-sector: environmental, social and governance (ESG).
Usually indices are calculated based on the market capitalisation of the included companies. This allows for greater weighting to companies with a larger cap and their performance influences an index’s value more than lower cap companies.
Other popular indices (Dow Jones Industrial Average) are price-weighted, which means greater weighting is given to companies with higher share prices. For example, any changes to these companies’ values will have a bigger influence on an index’s current price.
- DJIA (Wall Street) – tracks the performance of the 30 largest blue-chip companies in the US
- DAX (Germany 40) – tracks the performance of the 40 largest companies listed on the Frankfurt Stock Exchange
- NASDAQ 100 (US Tech 100) – tracks the value of the 100 largest non-financial companies in the US
- FTSE 100 – tracks the performance of 100 blue-chip companies listed on the London Stock Exchange
- S&P 500 (US 500) – tracks the value of 500 large cap companies in the US
What influences an index’s price?
Like with any other financial market, indices are influenced by market-moving economic data and events.
- Economic news: anything from market sentiment to Central Bank interest rate decisions and monetary policy announcements to employment market data, indices are sensitive to economic events.
- Company financial results: an index’s price can also be affected by an increase or decrease of an individual company’s shares following reports showing that such a company posted profits or losses.
- Company news: if a company has a big announcement relating to a change of leadership or mergers, its share prices can fall or rise, and this can affect the index’s price.
- Commodity market: Many shares on various indices are commodity stocks, so any changes in the commodity market will affect an index’s price too.
Is it better to trade stocks or indices?
Trading indices is sometimes preferred to trading shares or trading futures as it provides access to multiple companies at once. In other words, trading indices is a way to get exposure to an entire industry or economy at once, without having to open multiple positions on individual shares. Indeed, one of the many advantages of trading indices instead of stocks through CFDs is the flexibility you have to trade multiple stocks through one index instead of individual stocks, saving time and potentially, possibly money.
This kind of diversification, allows you to hedge against unexpected volatility and drops in company shares. For example, in an index you might notice that some company share prices fall over time, while others rise. This means that you balance your portfolio and any sudden movements in the market won’t affect your funds drastically.
An index’s value may experience volatility but this is not extreme unless a very important event has occurred such as a war, a market crash, natural disaster, etc. In this sense, indices are less risky than trading stocks individually as when you trade CFDs on stocks and the specific stock falls sharply, you will take a loss if you are speculating that it will rise. With an index, if a company in an index closes, another one takes its place. The worst possibility will be a drop in the index for a short period of time, but this will depend on the value of the failed company and the performance of the other companies in the index. While stocks can potentially perform quite well, they usually carry higher risks.
This is why an index is also sometimes preferred over individual stocks as price movement is smoother and less volatile. Because no single stock can affect the price movement of the entire index, price movement is usually more stable. With a large market like this, even low volatility can provide traders with several entry and exit points. Day traders and news traders find indices trading particularly attractive as indices reflect and respond well to wider global and geopolitical market-moving events.
When it comes to cash indices, traders can get a comprehensive outlook of the market and sentiment and is an effective tool to evaluate individual stock portfolios.
An index provides exposure to a whole industry. This means that you do not have to waste your time researching individual P&L statements and different companies’ news reports. You can take a long or short position by looking at market sentiment.
Trading indices: strategies and trading platforms
Because there is no definitive answer to what is the best trading strategy when trading indices, traders can explore, practice with a demo account and read available information on the market. At the end of the day, each trader knows how much capital they want to trade with, when and how they want to trade, so it is up to the individual trader to define what suits them best.
When it comes to choosing the right trading platform, a broker will provide access to the standard-leading platform MetaTrader4 as well as access to free education and tools to help you with your trading. MetaTrader 4 is a great choice for online traders who want to trade efficiently and with ease. It is simple to use and a good fit for beginners but it also provides advanced tools and functionalities for professionals, so everyone can explore trading opportunities on their desktop or on the go.
This information is not considered as investment advice or an investment recommendation, but instead a marketing communication. FXCess is not responsible for any data or information provided by third parties referenced, or hyperlinked, in this communication