An introduction to trading indices

An introduction to trading indices

Dow Jones, FTSE, DAX… these are the magical words you see every day in the news feed, the changes in their value create heart attacks for investors and traders and make the policymakers apply changes to their economies. But have you ever thought that you can trade these indices and it can easily boost your profit? Let’s find out how you can do it.  

The definition of an index

An equity index is a benchmark, which measures the price performance of several (mostly the largest) equities listed on the particular exchange. The value of an index is usually described in a number of points. Each index is calculated differently, but most often it is a weighted average of the current value of its stocks. A company with a higher capitalization impacts the most on its value. Due to the composite nature of an index, it reflects the health of a market or an economy, which it represents.

When you trade indices, you do not buy an ownership of an asset you trade. Instead, you trade on the changes in price, just like you trade currencies. You forecast the direction of the price of an index, open a position, and see where its price will go. If you are right, you will earn money.

Why choose indices instead of individual shares?

  • Indices will give you an outlook on international markets. When you trade indices, you understand the conditions of the companies and stocks they represent. For example, when you trade the FTSE 100 Index, you get an access to the movements of the biggest British companies.
  • It will help you to focus on the specific shares which comprise an index, instead of being torn between a wide choice of stocks.
  • Its diversified nature reduces the possibility of unexpected price movements based on the sudden news releases.

 Trading indices

 There are many factors which should be taken into account when trading indices.

  1. At first, study the parts which compose the index. Do equities which compose an index belong to one or several market sectors? The answer will help you to focus on the updates of a specific sector, which will possibly affect the value of an index.
  2. Look at the correlation between currencies and indices. The domestic indices tend to correlate with the conditions of a country's currency. For example, the value of American indices rises with the increasing demand for US Dollars. The reason for it lies in foreign investment: as traders invest in US stocks, they need to buy the greenback firstly. It will cause US indices to increase in value.
  3. Find out if the correlation between a country’s domestic index and commodities exist. For example, if a country is an oil exporter, its index will rise on the low crude’s prices. In case a country imports oil (Japan), its index will likely drop.
  4. Check the changes to index listings regularly. The stocks which compose an index can change due to market capitalization and mergers and acquisitions. The most valuable companies have the biggest capitalization. A market capitalization of a company is the total value of its issued shares assessed by the market. An index is affected by the individual share prices of the companies. For example, if a company's market capitalization declines, its stocks may become too small to remain on the index. Therefore, a company can be replaced with another one with bigger market capitalization. In addition, mergers and acquisitions (M&A) can also change the stocks listed on an index.

When a stock of index changes, the capitalization changes as well, which affect the final value of an index. That is why, it is necessary to follow the changes in index listings, follow financial statements and news for companies which issued those stocks.

What indices to choose for trading?

After taking the necessary steps on choosing indices to trade, you can analyze their charts on the MT5 trading platform. FBS gives you an access to trade some of the well-known indices.

Brazilian Stock Exchange Index (Indice Bovespa, IBOVESPA) – is the benchmark index which consists of about 60 stocks that are traded on the Brazilian Stock Exchange (B3, Bovespa: BOlsa de Valores do Estado de São Paulo).  The stocks on the index account for 80% of the volume traded in the last 12 months and that were traded at least during 80% of the trading days. It is also an indicator of the economic conditions of Brazil, as most of the companies listed were established there.

The Financial Times Stock Exchange 100 Index (the FTSE 100 Index, FTSE 100, FTSE, the "Footsie") – is a share index of the 100 companies listed on the London Stock Exchange (LSE) with the highest market capitalization. They represent about 81% of the entire market capitalization of the LSE. Many of the companies are international, however, the index is considered as an indicator of how the UK economy performs. It is also significantly affected by the price of the British pound. 

The DAX (Deutscher Aktienindex (German stock index) – is a stock index, which consists of the 30 major German companies trading on the Frankfurt Stock Exchange with the biggest market capitalization.

The Dow Jones Industrial average index (DOW, DJ) – is a stock index of 30 large publicly owned companies based in the United States.  The name “industrial” has the historical meaning as most of the modern 30 companies comprising the index are not connected with the heavy industry. Despite the American origin, it is affected by not only companies' data, but also by the world news, political events, and natural disasters.

HS index (HSI) – is a benchmark capitalization-weighted index, which tracks the performance of the 50 largest companies in the Hong Kong stock market. It is used as the main indicator to measure the conditions of the Hong Kong market. The stocks which compose the index must be among those that create top 90% of the total market capitalization of all shares and should have a listing history of 24 months or meet the requirements.

Conclusion

Despite its large figures and representative role of an economic sector or a separate economy, indices are easier to trade than it may seem. Moreover, trading indices also helps you to track the economic performance of different countries and to take an advantage of this knowledge when trading currencies.

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