Diversifying your trading portfolio is a great way to increase your chances of success.
The stock market receives high volumes of trades each day, which can be a prime location for your future investments. But instead of investing in individual stocks, there’s opportunity to profit from the collective price movements of a group of stocks.
This is known as indices trading.
As such, this article will provide you with a complete guide to indices trading, including what it is, how it works, and why it can be beneficial.
What are indices?
An index is what’s referred to as a group of shares from an exchange, collated together under particular criteria.
Different indices will have varied criteria that forms them together, based on weighting method or country, for instance.
Some examples are:
- The Financial Times Stock Exchange 100 (FTSE 100) – an index of the top 100 companies on the London Stock Exchange, measured by market capitalisation.
- The NASDAQ-100 (NDX) – an index of the top 100 non-financial companies listed on the NASDAQ Stock Exchange, measured using market capitalisation weighting.
- The Deutscher Aktien index (DAX) – known as the ‘Germany 40’, an index of the top 40 blue-chip companies on the Frankfurt Stock Exchange, measured by total market capitalisation.
- The Dow Jones Industrial Average (DJIA) – known as ‘Wall Street’, an index of the top 30 publicly-listed companies in the United States, measured by price.
How does indices trading work?
Indices trading can be executed in a range of different ways.
One method is through trading contracts for difference (CFDs), which can be beneficial, although complex.
When trading indices with CFDs, you don’t take ownership of the underlying assets, as you would do trading traditionally. Instead, you purchase contracts on an index, speculating on whether its price will rise or fall.
A long (buy) position, would be for when you expect the index price to rise, buying contracts and then selling for a higher price when closed.
A short (sell) position, would be for when you expect the price to fall, selling contracts with the promise of buying the same amount when you close – and hopefully when the buy price is lower.
The returns you gain from your trade will be based on the accuracy of your speculation – the more accurate, the more profit you gain.
Indices are continuously changing in value, so it’s important to be aware of all the things that could influence their movement, and thus your position.
What are the benefits of indices trading?
- Leveraged trading
You can use leverage when trading indices through CFDs, which allows you to gain greater exposure to the market for a much smaller deposit of capital.
If, for instance, a major index has a leverage ratio of 20:1, you can deposit £1,000 and trade up to £20,000 worth of CFDs.
As a result, you could deposit a small amount of initial capital, and gain substantial returns on a successful trade, calculated against your leveraged amount.
However, ensure you’re aware that any losses you receive will also be calculated against your leveraged amount, not your initial deposit. This is an important risk to consider when leveraged trading.
- Index shuffling
Another benefit on indices trading is that there’s always potential for index shuffling to aid your positions.
Due to the criteria of indices, there may be times where certain underperforming stocks are removed from the index and swapped with another growing stock.
This means any individual stocks which could be driving the entire index in an unfavourable direction (depending on it weighting), might eventually be reshuffled to help change the overall market movement.
- Rising and falling markets
With index CFDs, you can make potential profits on both rising and falling markets.
You can open both short and long positions, so whichever direction the market is headed, an accurate speculation can still bring you profitable returns.
This greatly expands your opportunities to identify any potential trends and profit from them, regardless of the trend’s nature.
Indices trading requires an in-depth understanding and skill to bring you success. With this guide, you now have all you need to implement indices trading into your portfolio, and explore new avenues for profit.