An increasing number of traders is interested in indices markets and CFD trading. Indices measure how a group of stocks performs. The idea is to focus on how strong and healthy a market is overall rather than focus on the growth of a single company individually. Indices are also referred to as stock indices or share indices. All in all, traders usually choose to trade indices since no single company can greatly impact the price of an index overall.
Also, traders trade CFDs on spot indices since it’s a more balanced way to trade the world’s top financial market. The reason is that you do no need to waste time and analyse how an individual company’s stock performs.
Keep in mind that there are numerous indices tracking various groups of shares. For example, the FTSE 100 in the UK tracks the performance of the 100 companies listed on the London Stock Exchange. Some other indices target a broader spectrum, such as a whole region, while others only focus on a specific sector.
How to get into indices trading
- Choose to trade indices on CFDs. CFDs refer to a contract between two parties to give back the price difference from the opening time of the contract to the point it is closed. Online indices trading on CFDs means that traders can speculate on the rising or falling price of indices rather than owning the actual asset.
- Open a trading account with an online broker. Go with a broker that offers a variety of trading accounts so that you choose based on your trading requirements and needs. Also look for a broker that offers low spreads, a variety of instruments and the best indices trading platform, like the MT4.
- Choose the index you prefer to trade based on your trading style. Your risk appetite, availability of funds and your preference for short-term or long-term positions will also determine your index choice. For example, if a trader has a high-risk appetite, might choose the Germany 40 which is usually a volatile index. Also, the US 500 is considered an index with steady returns in the long term which makes it a common choice among traders with a lower appetite for risk.
- Choose whether you will go short or long. If traders go long, it means that they are speculating on the increasing index value whereas if they go short if means exactly the opposite, that they are speculating on the decreasing value of an index. If the index rises in value, then a long position will help traders generate some revenue. If an index rises this means that the economic status of a sector is good as the companies that make up that particular index have performed well. If, however, the economic status does not look good because maybe companies are not performing well, then traders might want to take a short position, with the expectation that the value of the index will fall.
- Another important factor in online indices trading, is to set your stop and limit orders. These are important tools in managing risk. Stop-orders close your position automatically, once it reaches a level that is not as favourable as the present market price. Limit orders close your position automatically once it reaches a more favourable market price.
- Finally, open a trade and monitor it. Once you are ready for online indices trading, then the last thing to do is to open your trade. To do so, you go to the market you want to trade on your trading platform and decide whether you want to buy or sell. This will depend on whether you think the price will rise or fall. You then choose your position size and open your trade. You should monitor your position and if you want to take a profit or cut a loss you should close the trade.
How to calculate indices
The stock of a company is more broadly classified as large cap, mid cap or small cap. Indices are calculated by market capitalisation or price-weight. The former uses the market value of a company’s outstanding shares in total to evaluate the extend of its impact on the index. As a result, large caps, that is, the more valuable companies, will have a bigger impact on the total value of the index compared to mid or small cap. S&P 500, FTSE 100 and NASDAQ are examples of indices with market capitalisation.
The other way is price-weighted indices which use the share price of a company to examine to what extend it can move an index. Put simply, those companies that have higher share prices will more greatly influence these indices. If we put the share price of every stock together and then divide by the number of stocks in the index in total, we will have calculated the value of a price-weighted index. Dow Jones and Nikkei 225 are two examples of price-weighted indices.
Which factors influence indices movement?
- Prices of commodities
- Interest rates
- Share performance
- Economic data/news
- Company financial results and announcements
- Company industry news
- Alterations in an index’s composition
Benefits of trading indices
First of all, the requirement for an initial margin is low and leverage can be high. Also, trading CFDs on indices means that traders can take advantage of upward or downward movements in the prices of indexes based on their position. By speculating on the price of multiple stocks instead of buying individual stocks traders get more exposure to the market and get to diversify their trading portfolio.
Also, they get to hedge against any offcut to the exchange rate in their current portfolio. Last but not least, since the exposure is wider and the picture of the market’s performance is larger compared to trading individual stocks, there is also the opportunity to diversify trader risk.