An index allows you to assess how a group of assets has performed. This is typically a list of publicly traded companies along with their stock prices. Dow Jones is one such index that is popular all over the world and is known to have a steady performance. The Dow Jones Industrial Average (DJIA) traces how the 30 largest companies in the US are performing. When the average price of the 30 companies increases, the overall value of the DJIA goes up, and if the average of the same 30 drops, the DJIA’s value also declines.
What is Index Trading (For Beginners)?
Index Trading is known as purchasing or selling a certain stock market index. Investors predict if the index value would increase or decrease on the basis of many factors to decide if they’d like to sell or purchase shares. The index is basically an overall average of the stock performance, therefore you would hence you won’t be buying or selling any actual stocks but rather speculating on the performance of a group of stocks.
Trading indices online have two major types: cash CFDs and futures CFDs. What differentiates the ‘cash’ market and ‘futures’ market is that there are no expiry dates with cash. On the other hand, the ‘futures’ market comes with an expiry date referred to as a ‘rollover’. A futures contract is basically when a buyer and a seller are in an agreement about the price which a buyer has to pay at a preset date in the future.
Advantages of Trading Indices
- Indices are useful in gaining exposure to a targeted market and sector.
- Trading indices help you predict the potential movement of an underlying index without actually taking ownership of any shares.
- It requires only a small investment.
- The transaction costs are relatively low.
- Market trends are clear and work in favor of various trading styles without compromising on a trader’s creativity.
- Though it allows enough exposure to the market, it also gives enough room for risk management and offers protection against potential stock volatility.
- You can access international indices from a single account.
- Index reshuffling makes it possible to eliminate underperforming stocks and include the ones that do better.
How are Stock Market Indices Calculated?
In today’s technology-driven time, it is easy to calculate stock market indices prices with the help of approaches like market capitalization and the price weighting formula:
Market capitalization = Current market price per share X Total number of outstanding shares
Market capitalization is a more popular method that weighs the company’s stock by its overall market value. To find out what this value is, you need to multiply the number of outstanding shares by the present market value of a single company share. This methodology provides more weightage to firms that have higher share prices. It implies that any change in value would have an impact on the present price of the index it’s a part of.
Different Ways to Construct an Index
There are several ways to create an index, many of which focus on how different components of an index are weighed. Three key ways are as follows:
- A market-cap or capitalization-weighted index adds more weightage to those components in an index that have the largest market capitalization (market value), like the S&P 500.
- A price-weighted index would focus more on the components that have the highest prices like the Dow Jones Industrial Average.
- An equal-weighted index would give every component equal weightage, sometimes referred to as an unweighted index.
Easy Steps Toward CFD index trading
Pick Your Index
You can track hundreds of different indexes with the help of index funds. On the basis of the sector you’d like to trade, you can select an index that includes firms from the industry you choose.
Choose a Fund
When you’re done selecting an index, you have to pick an index fund so you can track it. Of course, you will find many funds which track the same index, particularly in the case of important indices such as Dow Jones and S&P 500.
Open a Trading Account
First, you need to register with a reliable trading platform and select an account that aligns with your trading requirement. Once your trading account gets verified, you will be able to explore many available CFD assets where you may come across the leading indices. If you don’t mind entering the markets, you could go ahead and start your first trade.
What Moves Index Market Prices?
Price movements largely rely on external forces. The price would typically decrease in uncertain times that weaken a country’s economic health. Some of these factors are as follows:
A few stocks within an index could be commodity stocks which could affect the price in case there are market fluctuations.
Events like natural disasters or pandemics hamper a country’s economy and thus affect the market as well.
Economic events and meetings like the ones where central banks zero down on rates, NFPs, trade agreements, and employment indicators could affect prices.
The prices might move if a company’s stock is included or removed from a stock index.
Important company news, like any change or new leadership, the merger of companies, or the release of financial reports.
Ways To Trade Stock Market Indices
Indices that are traded as CFDs allow you to speculate on the price movements without owning the underlying stock. For instance, as a buyer, you’re willing to pay the seller the difference that lies in the present value of the asset and the value when the contract expires.
The two key indices you can trade are:
These are the ones with tighter spreads that are based on spot pricing. Cash indices are often believed to be short-term investments. Cash CFD traders typically don’t keep their positions open overnight so they can avoid paying overnight trade charges.
Futures CFD trades are commonly used by traders who’d like medium to long-term investments. The contract pricing is done on the basis of payment to be made at a future date.