All You Need to Know About Trading Indices

Key Takeaways: 

• Most popular indices in the market include the Dow Jones, the S&P500, and the Nasdaq 100 
• Indices trading with TradeOr has a number of advantages like leverage and long/short positions 

What Is A Stock Index? 

An index, in the context of trading and financial markets, is perhaps the most common investment for both large institutional investors and small traders. To this end, a stock index is a way to measure the performance of a selected group of assets all at once.  

In more detail, these assets would be stocks of publicly traded companies. Every index has its own distinctive characteristics. One could hold mostly technology companies, as we will see a bit later, while another may be focused on real-economy stocks.  

The S&P500 would be an example of a stock index. It is comprised of 500 large-cap US companies, all neatly packed in 11 sectors. Some of these sectors include Information Technology, where the tech names are, or Financials, where you can find banking stocks. 

Heading over to the UK, the London-based FTSE100 tracks how 100 large-cap UK companies perform in any given moment during trading sessions.  

Trading indices is considered a safer investment relative to trading individual stocks or commodities. Let’s find out why it’s so popular. 

Why Trade Indices?  

Indices trading is straightforward and doesn’t generally involve the in-depth research that you would otherwise do if you were trading individual stocks. The reason being is that with so many companies, you’re essentially betting that the entire market will either move up or down.  

In other words, when you buy an index, you buy a fraction of all companies represented in the index. You could also decide to sell, which would mean you would sell all companies altogether.  

That doesn’t mean indices trading is simple. You still have to do your own research and decide where the general trend would move next. 

Still, indices trading has many benefits that you want to take into consideration: 

• Ample liquidity and high volatility – indices trading is one of the most liquid markets. You will always be able to find an opportunity and enjoy enough volatility to see your position move. 

• A conventional way to trade – indices trading is preferred by legendary investors such as Warren Buffett. This is because by owning an index, you own a whole nation’s economy.  

• Finding balance in your portfolio – the above reason also means once you get exposure to an index, you balance your portfolio and hedge your risk.   

• Buy long or sell short – indices trading goes both ways – you can either buy or sell. In both directions, you can expect to make money.  

• Safer investment than individual stocks – indices trading is far safer than trading individual stocks. Investing in 500 companies, instead of 1, greatly reduces your risk exposure. 

Types of Stock Indices  

Indices vary in the way they are structured, or packaged. These variations tend to be defined by the companies’ locations, their specific industries, or the size of their capitalization.  

Today, in the financial markets you can find several types of indices: 

Country-focused indices: Also called benchmark indices, country-focused indices are stock averages of whole economies. More precisely, they represent the best companies from a specific country.  

A benchmark index for the US is the Dow Jones Industrial Average, or US30, holding 30 large-cap real-economy companies. The DAX 40 (formerly DAX 30) is the German stock average, represented by 40 large-cap German companies.  

Exchange-based indices: This type of indices tracks stocks trading on a particular exchange. For example, the NASDAQ 100 trades on the Nasdaq exchange. The NASDAQ 100 is a non-financial index, meaning it does not hold banking stocks or other finance-related corporations. 

Region-based indices: These indices represent a specific geographic location. An example is the region-wide Euro Stoxx 50, which comprises 50 companies from the euro zone.  

Sector-based indices: These indices are focused on tracking the performance of companies from a specific sector. A sector, for example, could be consumer staples, financials, or healthcare.  

What Are The Best Indices to Trade?  

Indices trading would be understood best divided into the indices’ respective economies. The most popular indices operate in the US, Europe, and Asia.  

The Dow Jones Industrial Average (US30): The Dow Jones, for short, is one the most actively traded indices in the world. It’s also among the most cited ones from commentators to represent how the US stock market is faring on a daily basis.  

It comprises 30 publicly-traded companies that are focused more on value, and less on growth. Value-focused companies are cheaper relative to growth stocks like tech shares and are often in less-glamorous, old-fashioned industries. Examples of companies in the Dow Jones are Coca-Cola and Goldman Sachs. 

The S&P500 (SPX500): Another heavyweight in the US, the S&P500 index comprises 500 large-cap companies, as we mentioned above, divided into 11 sectors. A broad-based stock gauge, the S&P500 is right next to the Dow Jones in terms of popularity and attention. It includes companies like Apple, Netflix, and Pfizer.  

The Nasdaq 100 (NAS100): This is the tech-heavy index that tracks the performance of the big names in technology. The Nasdaq 100 comprises 100 large-cap non-financial stocks such as Meta Platforms (formerly Facebook), PayPal, NVIDIA and others. 

The Euro Stoxx 50 (EUSTX50): Europe’s leading benchmark index, the Euro Stoxx 50 tracks 50 public companies from the euro zone.  

Other big indices that are widely traded on a daily basis include the German DAX40, UK’s FTSE100, the CAC40 in Paris, and Japan’s benchmark index Nikkei 225. 

What Drives Index Prices?  

Index prices move every day, driven by several factors. These factors need to be heavy enough to propel such large amounts of capital in either direction. The US stock market, for example, is valued at $51 trillion in February 2022.  

In this light, large-scale events that move indices include: 

Economic news and updates: News is the leading reason for any particular index to trade. Positive economic news suggests the native index will be favored by investors and accelerate to the upside. On the other hand, negative news will likely pressure the index, leading to a decline.  

Such economic news might be interest rate changes by a central bank, or a monthly employment report, like the nonfarm payrolls in the US. Besides these two major drivers of index prices, other news may be GDP data and less-impactful economic reports like the weekly jobless claims.  

Political developments: On the politics front, certain events could change market mood, especially if there’s a large dose of uncertainty involved. These events could include presidential elections, geopolitical tensions, trade wars, or just major political shifts like Brexit.  

Company announcements: While not very common, it happens sometimes that an announcement from a single company might pull a whole index higher or lower. Recently, this happened with Microsoft’s acquisition of Activision Blizzard in a $69bn merger. On the day the news was revealed, the software giant singlehandedly propelled the S&P500 into the green for a whole trading session.  

Market moods and sentiment: At times, the market moves not because of news, but because of market sentiment and expectations. Quickly shifting market moods may lead to euphoric trading followed by a hasty rush to the exit. 

Developing a trading strategy  

Indices trading can be done in many ways through the use of a number of indicators, tools, signals, and resources. But the two main paths towards trading indices are fundamental analysis and technical analysis.  

Fundamental analysis is essentially trading on news and market developments. In other words, anything out there in the media that can influence index prices, you need to know it.  

Moreover, fundamental traders are always monitoring latest and upcoming data in the economic calendar. During news time, like the non-farm payrolls release every first Friday of the month, index prices may become heavily volatile. 

The other trading strategy is technical analysis. In it, traders analyze price behavior as seen on the trading chart. Technical analysis includes several major approaches: 

Trend following: This type of technical analysis aims to spot trends in their different stages. If a trend is in its early phase of formation, long-term traders might pile into it and wait for the move to occur. It could also be near the end, where a trader could expect a trend reversal. Or in the middle, which could present a short-term trading opportunity.  

Support and Resistance: Technical traders rely a great deal on channels and trading lines. Such lines are support and resistance. This strategy is ideal if you are looking for inflection points, or trend reversals. Support is where the trend meets a previous bottom and could rebound. Resistance, on the other hand, is the point where the trend meets a previous high and is expected to reverse.  

Chart patterns: A popular strategy among technical analysts, chart pattern trading aims to identify certain models that are being formed on the chart. In other words, technicians believe price moves in patterns. And their job is to spot these patterns and anticipate a move that could bring them profits.  

How to Trade Indices  

Indices trading is practically a matter of a few clicks, provided your broker offers these financial products. The most likely way you will be trading indices is through CFDs, or contracts for differences.  

What does this mean? CFDs are the most common way for traders to get exposure to indices, stocks, currencies, etc. In this light, by owning a CFD on an index, you do not need to hold the underlying asset, i.e. the index. But you still get the same benefits, and even more. 

Trading CFDs on indices gives you two main advantages: 

Leverage: Financial leverage is as old as the hills. From modern retail traders, to the pioneers in the investment business, leverage has been a crucial part of any trading strategy. In essence, leverage gives you the power to trade larger amounts of money than what you have deposited in your account. This will guarantee you increased trading profits, but also can turn against you if the trade doesn’t pan out.  

Ability to trade both directions: Another benefit of CFD trading is you can go both long and short in your trades. If you believe an index is about to go down in value, you can short sell it. And vice versa, if you believe it will go up, you can buy it.  

Risks of Trading Indices 

Indices, like any other financial instrument, have certain risks involved. Trading indices, for that matter, carries a risk to your portfolio. In detail, the volatility, coupled with high leverage, might be detrimental to your account if the trade turns against you.  

Moreover, if you do not use a stop loss order, you risk running into a margin call. In other words, having your account close to being wiped out. It’s important to make sure you have a robust trading strategy in place so you could withstand market risks and challenges.  

Risk management strategies  

To make sure any risk is calculated when trading indices, keep a strict and disciplined approach with every trade you make.  

To properly do that, you need to: 

Determine your investable amount: Choose how much you want to risk. It’s a common rule not to invest more than 2% of your funds in any single trade. 

Use stop loss and take profit orders: This rule will most likely be your top priority when approaching index trading. A stop loss order will automatically close your trade if it turns against you at the level you’ve specified. A take profit order will automatically close your trade in profit at the level you’ve specified.  

Use the economic calendar: Stay in touch with all news and developments that may sway indices both ways, up or down. The economic calendar will be your guide as to what you can expect to unfold in financial markets.  

Summary 

Indices trading is part of almost every successful trader’s portfolio. To this end, it’s important for you to understand what an index is, how it trades, and how can you get the most out of it.  

At TradeOr, when you trade indices as CFDs, you get key advantages such as leverage and the ability to trade in both directions. Moreover, our cutting-edge trading platform allows you to stay in touch with fundamentals like news, and also use technical analysis, monitor indices trading hours and much more.  

 

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