What is indices trading?
Indices, or indexes, measure the price changes of a particular group of stocks over time. They allow trading the value of many companies as a single product. Stock market indices are also used to track how an industry, economy, or sector performs in general.
Here are some of the world’s major indices:
- Dow Jones (US30) – tracks 30 large, publicly traded US companies
- S&P 500 (US500) – tracks 500 large-cap US companies
- FTSE 100 (UK100) – tracks the 100 largest companies listed on the London Stock Exchange
- Australia 200 (AU200) – tracks the 200 largest companies listed on the Australian Securities Exchange
- Nikkei 225 (JP225) – tracks the 225 largest companies listed on the Tokyo Stock Exchange
As the index is basically a figure that reflects the health of the market or economy, it cannot be bought or sold directly. Thus, you can trade indices via CFDs (Contracts for Difference), ETFs (Exchange-Traded Funds), index funds, index futures, or options.
How to start indices trading?
The most popular way to start trading indices. Find out the best index funds to invest in. This financial instrument allows traders to profit from the difference between the opening and the closing price of an underlying asset – in this case, an index. You can trade indices in both directions, just as if you trade currency pairs. You can potentially profit from both rising and falling prices.
For example, if you think the index will rise, open a long (buy) position. But if you think the index will fall, open a short (sell) position.
To trade stock indices effectively, you first need to understand what their price depends on. It is generally driven by the news (e.g., earning reports), political issues, and global economic situation. It is also worth using technical analysis.
Learn more about how to trade indices with videos from FBS market experts.
What are the risks of indices trading?
Indices trading is considered a relatively secure form of trading, especially for a long-term investment, as you are spreading your risk across an entire segment of stocks as opposed to a single stock.
However, some volatility risk still remains. Stock indices can go up or down for a variety of reasons. But unfavorable price moves can lead to losses, especially if you cannot react to a price change immediately.
Collecting news and analysis will help you to make better decisions. It is also a good idea to use risk-management tools. Choosing tools such as Stop Losses, Limit Orders, and Trailing Stops will help you to protect yourself from volatility.
Indices vs. Forex: What is the difference?
Volatility. The Forex market is highly volatile. You need to predict the movements of a single currency pair, which can be influenced by numerous factors. On the contrary, when trading indices, you predict broad movements of a certain stock market, which is less volatile.
Liquidity. Some stock market indices are less liquid than the Forex market (which is the largest and most liquid market globally).
Time strategies. Indices trading may be more suitable for long-term traders. On the other hand, Forex trading tends to be more convenient for short-term traders who prefer to profit from small price changes.
Leverage. In FBS, Forex trading has the maximum possible leverage – 1:3000. Indices are traded with leverage up to 1:33.
Please keep in mind that it is better to choose trading instruments depending on your trading strategy, level of knowledge, understanding of the particular market, and risk tolerance.
What time can you trade indices?
You can trade indices during the main market hours of a chosen index. For the US indices, trading hours start from 15:00 to 0:00 MT time. See a full list of market hours for indices trading.
What are indices?
There are hundreds of thousands of companies that trade their securities on the stock exchanges. Indices come in handy when you have to track changes in the prices of the countless securities and understand the sentiments of the market. Indices make it possible to assess the state of the stock market as a whole and to determine the current moment in the economic cycle.
Investors use stock indices both to estimate the situation on trading platforms and to predict future trading results. Indices are calculated for different countries, industries or for a certain group of securities: stocks, bonds and other assets.
How are stock market indices calculated?
Indices are divided into groups according to their calculation methodology. Some of the most common are:
- Arithmetic index. The market prices of the shares included in the index are added up and the resulting sum is divided by the number of included shares.
- Weighted average index.The calculation involves the multiplication of each number in the data set by a predetermined weight. In price-weighted indices, each company's stock is weighted by its price per share, and the index is an average of the share prices of all the companies. As a result, stocks with higher prices have a bigger impact on the movement of the index than those with lower prices. An example of such an index is the Dow Jones Industrial Average (DJIA). In capitalization-weighted indices, also known as market value-weighted indices, the weighting of a particular stock is determined by its total market capitalization. In such indices, stocks with a larger market cap have a higher weighting and any movements in their share prices will have a larger impact on the index performance. The most familiar example of such an index is the Standard & Poor's 500 (S&P 500).
- Geometric average index. It is calculated from the growth rate of stock prices. Indexes of this type include the FT 30 Index created by the Financial Times and the Value Line Composite Geometric Index.
Benefits of index trading
In general, indexes have several purposes.
- To get an idea about the general dynamics of stock quotations of a certain group (companies, countries, industries, etc.). Often this data is used for speculative trading.
- Getting information about investors' attitudes. If indices are increasing it means that investors have a positive attitude to investments in certain stocks.
- Indexes monitoring over a long period of time gives an idea about the investment climate in a certain country.
- Often, in addition to the index value itself, information is published about the total turnover of shares of its constituent companies. Changes in these figures give an indication of the overall activity of traders in the market in transactions with securities of a certain type.
What are the most traded indices?
The most well-known international indices that you can trade with FBS include:
- NASDAQ 100 Index (US100),
- FTSE 100 Index (UK100),
- Nikkei 225 Index (JP225),
- Australian Stock Index (AU200).
How to choose traded indices?
To choose indices for trading, first of all, you need to pay attention to the factors that can affect the quotes. Namely:
- Macroeconomic indicators. GDP, the level of industrial production, trade balance. Even the levels of inflation and unemployment can have an impact on quotations. For example, an increase in unemployment in conjunction with other indicators may indicate a decrease in consumption followed by a decline in company revenues.
- Economic and political events. US elections, military conflicts, sanctions, trade wars, international trade agreements all affect the future profits of companies, and consequently, indices.
- Traders’ sentiments. These are traders’ attitudes to market and economic prospects. The majority opinion plays a big role.
Index futures for hedging
Index futures is a type of contract in which a stock index serves as an underlying asset. In other words, it combines the qualities of both a futures contract and a stock index.
Investors often use index futures for hedging, opening short positions against the stocks in their portfolios. The underlying assets are not the shares of a single company, but of a number of companies. It means that the risk of a complete collapse is minimal. Even during the crisis, investors who hedged their portfolios with index futures emerge from the crisis with minimal or no losses.
Using index futures to speculate
In addition to hedging, experienced traders use index futures for speculation on the price movement of an index. This means that a trader buys or sells index futures to bet on the direction of price of a group of assets.
Stock indices are not just analytical information. This is a full-fledged working tool, with which you can make independent transactions, assess the state of the industry, and conduct fundamental analysis of the market. And on top of it, the risks of index trading are always lower than those of investing in individual stocks.
2022-11-22 • Updated