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How to Trade Indices? Trading Indices CFDs Explained

Index trading can be best described as the buying and selling of a specific stock market index. Instead of speculating on the price of a single stock, currency pair, or commodity – Trading indices enable investors to get exposure to a certain sector, market, or an entire economy. 

So, if you want to start trading indices, you need to be aware of all the methods by which you can get access to indices trading. In this article, we also explain what indices CFDs are, list the main factors that impact stock indices prices, and provide tips to start trading stock global indices. 

Key Points to Take Away

  • Stock market indices are used to monitor and measure a certain market performance. Some of the most popular indices include S&P 500, Dow Jones Industrial Average 30, NASDAQ100, FTSE100, DAX30, Vix, etc.
  • There are various ways to trade stock market indices including futures, ETFs, options, and CFDs.
  • The most popular method to trade global stock indices is through Contracts for Difference due to the high leverage and low entry barrier.

What Are Indices?

Generally speaking, most people are familiar with stock indices, even if they are not traders or have an interest in financial markets. Basically, stock indices were designed to measure the performance of a certain stock market by creating a basket of the best-performing individual stocks in an exchange and tracking the performance of these stocks. 

For example, the S&P 500 is an index that tracks the performance of the largest 500 companies listed on all US stock exchanges. The US dollar index measures the value of the US dollar versus a basket of the most traded currencies in the world. 

FYI

According to Wikipedia, there are currently 228 major stock and commodity indices in the world.

Indices Trading – How Does it Work?

Each way has its own merits and is suited for different types of traders. But because indices are simply benchmarks and there’s no value for trading different contracts (expiration date, size, etc), then the majority of traders are looking to trade cash indices that trade at spot price.  For that reason, trading index CFDs has become an extremely popular method to get exposure to these financial instruments. 

With CFD trading, investors can trade stock indices with a leverage of around 10:1 to 200:1 (SwitchMarkets enables investors to trade indices with a leverage ratio of 200:1, or a margin of just 0.5%). Furthermore, CFD brokers often enable traders to start trading with a fairly low initial investment and with a variety of trading platforms, tools, and features. 

But, regardless of the method you choose to trade indices, you need to remember that the process of trading indices is similar to trading any other financial instrument. Investors simply speculate on the price market movement of the index by analyzing the economic health of an economy or a certain market. For example, over the last years, tech stocks are booming in the United States and across the globe, and consequently, the NASDAQ 100 stock index has a YTD return of over 20% and a 1-year return of nearly 35% at the time of writing. 

How Are Stock Market Indices Calculated? 

Stock market indices are calculated in different ways – by market capitalisation, price, or a method of equal calculation. But the vast majority of stock indices are calculated and weighted according to the market cap of the index’s companies. With this method, large-cap companies have a greater impact on the index performance. For example, the S&P 500 is a market capitalisation-weighted index of 505 of the largest companies listed in the US. Apple corporation has a weighted average of 6.05, which clearly makes it a dominant stock in the index, and its performance will have a larger impact on the S&P 500 performance than small-cap companies like Western Union (0.02).

Below, you can find a table of the most traded stock indices in the world as of 2021. 

IndexCountryTracks the Performance of:Available at SwitchMarkets
S&P 500United States505 largest companies listed in the USYes
Dow Jones 30United States30 largest stocks in the USYes
NASDAQ 100 (US Tech 100)United States100 largest tech stock in the USYes
FTSE100United Kingdom100 largest companies listed in the UKYes
DAX 40Germany40 largest companies listed in GermanyYes
Nikkei 225Japan225 largest companies listed in JapanYes
Cac 40 France40 largest companies listed in FranceYes
S&P/ASX 200Australia200 largest companies listed in AustraliaNo
VIXUnited StatesMeasures the US stock markets expectation for volatility – used to measure the risk and uncertainty in the stock markets No

*Other popular stock market indices include the FTSE China a50 Index, the US Dollar Index, Ibex 35 (Spain), EuroStoxx50, Hang Seng Index, S&P/NZX 20 (New Zealand), Shanghai SE Composite, etc. 

Trading Indices vs Forex

Most of the new traders that enter the trading scene often ask which asset class is better to start with – stock indices or forex. For various reasons, most people are going straight to trading forex, which can be attributed to the fact the forex market is easier to understand and predict, and it is the most liquid market which is exactly what new traders need. 

However, in my opinion, there’s no preference for a specific market between the two. Also, there’s no reason for a trader not to take advantage and trade both markets, especially when there’s a correlation between the forex and stock markets as well as between commodities and stocks. 

Still, there are crucial things to take into consideration. First, in terms of the leverage ratio provided by brokers – you’ll be able to get higher leverage when trading forex. For example, SwitchMarkets provides a leverage ratio of up to 500:1 for forex trading and 200:1 for indices trading. That said, a high leverage ratio is not necessarily a good thing, particularly for swing and long-term traders. 

Secondly, liquidity. Beginner traders need a liquid market so they will not get stuck in a liquidity trap where there’s a market with no buyers and sellers. When we compare indices vs forex – then the forex market certainly has higher liquidity. Having said that, when trading CFDs, liquidity is not a factor as the broker ensures you get market execution at any price. Therefore, trading indices CFDs is perhaps the best option for a trader to be able to buy and sell indices. 

Finally, volatility. On this argument, it is difficult to find a decisive answer. Some say the forex market is more volatile than the stock market and some say the opposite. Nonetheless, both currency pairs and stock indices are great assets for intraday and long-term trading so there’s no reason to focus on only one market.

How to Trade Indices?

As mentioned above, a trader has several options to trade indices. One effective way to do so is by contract for difference (CFDs), which allows the user to trade with leverage and by getting access to a top-notch trading platform. To start trading index CFDs, you simply need to follow the next steps.

  1. Open an online trading account with a regulated broker that offers indices CFDs
  2. Fund your trading account. We suggest you start with the minimum deposit required by the broker. 
  3. Select the index you want to trade on and follow market news and economic data that has an impact on the chosen index
  4. Buy or short sell the index
  5. Use risk management tools such as a stop-loss order, and risk-reward ratio

Factors that Affect Stock Market Indices

Still, when trading stock indices, there are some factors affecting the stock market that you need to consider:

  • Macroeconomic news and data: News and economic data have an impact on market sentiment and normally cause changes in indices prices. These include central banks announcements, economic data (GDP, CPI, Non-Farm Payrolls, etc), economic outlook, analysts’ forecasts, etc.  
  • Changes in stock index composition: Most index providers often rebalance their indexes by removing and adding companies. In this case, investors respond to such information, and the index is affected by the change in composition (usually, the index will be positively affected by the change in an index composition). 
  • Companies’ earning results: Public traded companies are required to release their earnings reports four times a year, a phenomenon known as the earrings season. During this time, the stock market is extremely volatile and the reports of individual companies have a direct impact on indices price movements. 
  • Economic and political events: Factors like political instability, war conflicts, elections, and budget disputes can significantly affect economic growth and stock prices. 
  • Inflation and interest rates: There’s a negative correlation between inflation and stock prices. When inflation rises above the target range (typically between 1-3), central banks are forced to increase interest rates, which negatively affect stock price and stock market indices. 

Tips for Trading a Stock Index

Generally, there are many different ways to trade indices. Some are more conventional while others are unique and come in a way of thinking out of the box. For example, while I was working in a dealing room, one trader found a strong correlation between the NASDAQ 100 and DAX30. It worked for him. 

Another trader has had a very unique strategy that focuses on buying or selling an index when there’s a daily change of above or below 2.5%. In this case, for example, if the NASDAQ100 rises above 2.5% during a trading day, the trader goes with the trend and buys the index and vice versa. 

What’s more, some traders see the crude oil market as an early indicator of the stock markets. According to this strategy, changes in oil prices are a way to predict future price movements of stock indices

All in all, you can find many trading strategies to trade stock indices. In any case, it is best to establish a trading style that combines fundamental and technical analysis and understand the main factors that drive stock prices.  

Fun Fact

The Dow Jones Transportation Index was the first stock index published by Charles Dow in 1884. 

Final Thoughts

All things considered, trading indices is certainly a great way to get exposure to stock markets around the world. It is probably not the easiest market to trade due to the complexity of stock markets, however, following stock indices will help you find lots of trading opportunities.  Additionally, there are many benefits to trading indices. It’s easy to get information from news websites about a certain index, you can trade with leverage, and you have the ability to take long and short positions. 

To get started, you need to decide on the way you want to get access to index trading. This could be done either with a share trading brokerage firm or a CFD broker. If you are a beginner, you can open a free demo account to get access to the markets and practice indices trading with virtual money. 

FAQs

Is it possible to invest directly in a stock index?

In essence, you cannot buy an index directly from the exchange. The reason for that is that an index is not a security but an indicator that tracks the performance of a certain market. However, there’s a way to do that by buying the exact companies listed in an index, a strategy called indexing. This could be normally done on indices that track a small number of stocks rather than indices like the S&P 500, or Nikkei 225.  

How to trade world major indices on MT4?

To be able to trade major indices on MetaTrader4, you obviously need to find an online brokerage firm that gives users access to this platform. Here, at SwitchMarkets, we offer traders to trade a range of 8 stock indices with a leverage ratio of 200:1 on MT4. 

Which stock index is the most volatile?

In the US, two of the most volatile stock market indices are the NASDAQ 100 and Russell 2000 index. In Europe, the DAX30 is known as one of the most volatile indices in the world. 

What are index futures?

Stock index futures are derivative contracts that trade on various futures exchanges such as the Chicago Mercantile Exchange. These futures are cash-settled and allow investors to speculate on the price movement of different indices.  

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