An Advanced Guide to Trading Indices – Reader’s Digest

A guide on trading indices.

If you are an avid trader or are researching your options, you may have come across indices. This refers to the measurement of a collection of shares from a single exchange in terms of price performance. If you decide to trade with indices, you will have the opportunity to utilise the potential of a whole sector or financial economy with only one open position.

A bit about indices

With index trading such as the FTSE 100, traders speculate on prices rising and falling – and as this is a particularly liquid market with long trading hours, there can be positions to take advantage of. On the stock market, they are typically calculated using the market capitalisation of the component companies, but some will be price-weighted to give more substance to companies with greater share prices.

It can be important to understand what moves an index’s price to be able to make better-educated speculations, and the main factors are economic news, company announcements and financial results, changes to an index’s composition and commodity prices.

Trade using leverage

Leveraged trading allows individuals to borrow a percentage of a trade position alongside their own collateral (often known as a margin). When you only need to commit a small amount, you’ll have better access to trades and profits.

When it comes to trading indices, one of the top leveraged products used is CFDs (Contracts for Difference). These are the contracts made between traders and brokers to exchange the difference in price from the opening and closing points of positions and can be made using an online platform to trade indices.

With leverage, profits and losses are calculated via the size of the full position and not just on your margin, so be aware that losses can be greater than your own initial bet.

The risks

Trading with leverage can be risky at all levels. In order to mitigate yourself from risk, ensure you practise your trading strategies on demo accounts. Ensure you have carried out sufficient research into market and economic trends before placing trades too. Once you’re ready to place a live, utilise stop losses to protect yourself from large losses.

Why trade indices?

Firstly, there are a whole host of stock indices available on the open market today that traders can get involved with. The leading ones are:

The FTSE 100 index
The Dow Jones Industrial Average
The S&P 500 index
The NASDAQ 100
The DAX 30
The Nikkei 225
The ASX 200

It can be a worthwhile idea for many traders to look into their potential, so here are just three advantages of index trading:

1. Portfolio diversification

There are many ways to diversify your portfolio, but indices have the added benefit of taking up a position that covers a range of companies – so if one fails, your overall bet won’t necessarily be affected.

2. Minimised risk

With the above point in mind, the risks of trading indices are fewer than that of other trading vehicles, such as Forex. Volatility is one of the biggest drawbacks when trading, but having shares in more than one company at once can safeguard traders from significant drops in any one at any given time (this can still happen, but won’t have the same impact as trading in one asset alone).

3. Research and trading strategies

It’s no secret that trading can require extensive amounts of research and a solid trading strategy to improve the chances of making profitable financial moves. The good news is that with indices, a general overview of economic trends can in some cases be sufficient enough to assist with the positions you choose. At its core, a trader needs to know is whether a market has the potential to grow in the future (if so, they will buy an index CFD), or if there may be a downturn on the horizon (if this is the case, they will sell instead).

There are disadvantages to keep in mind, however. For example, traders may find that brokerage fees are higher on less-favourable indices, there is less liquidity in index markets than in others and if profits are denoted as capital gains, they can be subject to higher tax rates. The risks of leveraged trading also apply if you trade using CFDs.

Is trading indices worthwhile?

Many traders find indices attractive as there is potential to enter both regional and global markets with little research. The fact that these endeavours can be leveraged has its pros too and the risks are reduced overall. Any trading vehicle you use will involve risks however, so be aware of all the pitfalls as well as the advantages before putting your money on the line.

Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. The vast majority of retail client accounts lose money when spread betting and/or trading CFDs. You should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money.

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