Fuelled by the growing interest in investing, some may be looking to try their hand at trading indices and exploring the long and short-term options available.
An introduction to index trading
A lot of people may be familiar with the concept of forex trading or stock trading, which are the buying and selling of currencies and shares, respectively, guided by market conditions and the possibility to capitalise on fluctuations. Now, bring in index trading, the slightly more complex form of trading. Although the underlying principles of trading remain the same, index trading applies to a specific stock market index. Simply put, it is trading on the performance of a group of stocks, which may be speculative, based on the average of the group and not a single stock. The value of the index increases if the price of shares of the companies listed increases, and vice versa.
With the multitude of tools and software at traders’ disposal in the digital age, calculating stock market indices has never been easier. Using the price weighting formula and market capitalisation are two ways of doing so, with the latter being touted as the most commonly used alternative. When one thinks of the major indices in the world, the likes of the Dow Jones Industrial Age (DJIA), S&P 500, FTSE 100 and Nasdaq 100 come to mind. These are named amongst the most notable indices because many blue-chip stocks are listed on them. For example, listed on the FTSE 100 are the likes of British American Tobacco, Unilever, AstraZeneca, Barclays and BHP, amongst others. Nasdaq 100, on the other hand, boasts tech giants such as Apple, Facebook, Amazon and Microsoft, to name a few.
How to trade indices
For those looking to start trading indices, it is advised to get started through trading Contracts For Difference, commonly referred to as CFD, which allow traders to speculate on the price movement. However, it is important to note that CFDs do not give you actual ownership of any asset, as the transaction is primarily based on the difference between the current value of the asset and its value when the contract expires. There are primarily two ways of trading CFDs; Index Cash CFDs and Index Futures CFDs.
Index Cash CFDs
This option is for short-term traders as it is based on spot prices. These types of traders also generally do not maintain a position overnight. This is said to be a move to avoid paying overnight trade charges, as they reopen trades again the following day.
Index Futures CFDs
This option is most popular amongst medium to long-term traders. Index Futures is based on an agreed upon future value, and the overnight funding charges are included in the wider spreads, which is not the case with Cash Indices, as they have much tighter spreads.
Should you want to learn to trade FTSE 100 and Nasdaq 100, it should be with an understanding of what moves index market prices, so as to avoid potentially huge losses. Prices are affected by factors such as global conditions, as was seen in 2020; economic news such as rate changes and key central bank decisions; the addition or removal of certain company stocks within the index; and of course, internal company news such as mergers and acquisitions, financial results and new leadership.