Indices are an asset class that is quite popular among traders. For those who are unfamiliar, an indice or index is a collection of assets that gives traders an average price to look at, making it easier to follow the price movements of a market or an industry. Stock indices are the most common and these can combine stocks based on the size of the company, its industry, or some other characteristic. Each country has one or more indices based on their stock offerings, and large financial markets such as the U.S. or U.K. will have many different indices. You will also find that major economies also have what are known as “benchmark indices” which combine the largest or most important companies. This means indices give a rapid view of the condition of financial markets, allowing traders to make predictions on the future movements of asset classes.
There are a number of popular indices from around the globe, although arguably the most popular indices are those found in the U.S. That includes the benchmark S&P 500 index, along with the Nasdaq 100, and the Dow Jones Industrial 30. Outside the U.S., traders can also find some potential opportunities. In the U.K., the FTSE 100 and FTSE 250 are both popular, with the former more focused on multi-national companies and the latter focused on domestic U.K. firms. Across Europe are many popular indices that include the DAX 30 in Germany, the CAC 40 in France, and the FTSE MiB in Italy. Moving on to the Asian region we find the Nikkei 225 in Japan, the S&P/ASX 200 in Australia, and the Hang Seng in Hong Kong as some of the most popular indices.
The fact is you can’t actually trade an index directly. The indices are simply a measurement of the markets, not an actual tradeable instrument. However, there are some ways around this. Exchange traded funds, or ETFs, have been created to mirror the performance of most of the major indices around the world and that’s one way to trade in indices. The downside to trading in ETFs is the fees and commissions you might have to pay. Another way to trade in Indices is to use the popular contract for difference (CFD), which is a way to speculate on the change in the value of the index.
Changes in the value of indices are a normal thing. The index value is affected by the prices of the underlying stocks that comprise the index. Because indices can be calculated in several different ways (by market capitalization, by price weighting, etc), the changes in an index are not always what you might expect. For example, the Dow Jones Industrial Average is price weighted, with each component having an equal weighting. This can create some interesting fluctuations. For example, when a stock splits its value is also lowered to account for the split and that can have an impact on the DJIA if the stock is a part of that index.
While trading in stocks can be interesting, some traders prefer to focus on trading indices as this comes with a number of benefits. These benefits include reduced risk that’s created by the diversity of the index. Reducing risk can help smooth out returns in the long run. However, don’t forget that risk is always involved even if it is reduced. Another benefit of that diversity is that it provides a measure of money management in as much as you aren’t putting all your money in one individual stock. Perhaps one of the greatest benefits to trading indices is their personalities and the ability that some traders have to read the movements in the indices very well. The indices are far less likely to see odd moves and even if they do the broad nature of the index keeps those moves more modest in comparison with individual shares.
Just as leverage increases the potential gains in any indices CFD trade, it also increases the potential losses. This makes leverage a double-edged sword and both a benefit and a disadvantage when leverage is not used properly. Another disadvantage, often not considered by aspiring indices CFD traders is the amount of research and knowledge required to successfully predict indices movements. The markets are very complex and it isn’t unusual for traders to get caught by geo-political risks they hadn’t considered.
