Every 24 hours, millions of investors across the world execute various forms of trades in several markets. When you have a full knowledge of all these different forms of trading, you can better diversify your trade portfolio.
With this being said, one popular form of trading used in many markets is indices trading.
Throughout this article, you’ll receive a full how-to guide on indices trading. This includes what indices trading is, what financial derivatives are used in the process, what is long and short in trading, and which markets can be traded.
Read on to learn this and so much more.
What is indices trading?
Indices trading is the process of trading an index, or multiple indices, on a particular market, and using this to gain potentially profitable returns on your investments.
An index is a collective group of assets on a certain financial market, which can be traded together as opposed to individually.
Every index will be created using a certain criteria, which determines the assets involved in the group. This can vary down to the specific index, or the type of market it’s found on.
You can trade indices on the stock market, for instance, where you can invest in the collective performance of different stocks at once, instead of trading them one at a time.
Here are a few examples of some popular indices, and under what criteria they’re grouped together:
- The NASDAQ-100 (NDX) – This index contains the top 100 non-financial companies listed on the NASDAQ Stock Exchange, measured by market capitalisation weighting.
- The Financial Times Stock Exchange 100 (FTSE 100) – An index holding the top 100 companies on the London Stock Exchange, measured using market capitalisation.
- The Deutscher Aktien index (DAX) – This index, also known as the ‘Germany 40’, contains the top 40 blue-chip companies on the Frankfurt Stock Exchange, measured against total market capitalisation.
- The Dow Jones Industrial Average (DJIA) – An index, known commonly as ‘Wall Street’, made up of the top 30 publicly-listed companies in the United States, measured by price value.
Whether you’re trading on the stock market or foreign exchange (forex), for example, indices trading is a complex process that requires dedicated strategy and skill, in order to produce the highest chance of profit with each investment.
How does indices trading work?
There are various ways in which indices can be traded, and it all comes down to the skill and knowledge of the individual trader, as well as their own preferences with how they want to approach each trade.
One method of trading indices which, although tricky, can bring great opportunities for success, is using contracts for difference (CFDs).
CFDs are financial derivatives that allow traders to invest in an asset using price speculation, as opposed to other traditional styles of trading.
With traditional trading, you’d need to deposit enough capital to take full ownership of the underlying asset. In order to then gain a profit, you’d need this asset to increase in price value, so you can sell it for more than you purchased it for.
When trading CFDs, you don’t take ownership of the underlying asset, but instead purchase contracts (units) that speculate a specific price movement – a long or short position.
Opening a long position on an index speculates a price rise. You’d purchase contracts on the index with the intention to sell them at a higher price once the index value increases.
Opening a short position is the opposite, and speculates a price fall. You’d sell contracts with the intention to buy them back again at a lower price, once the market has fallen.
Trading indices using CFDs relies heavily on the accuracy of your position, so it’s crucial you conduct extensive analysis of the markets you intend to trade on, and thoroughly asses each index for any profitable opportunities.
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Like any form of trading, the best way to secure a profit and increase your chances of success with indices trading, is to build your approach on knowledge, skill, and responsible strategy, whilst bearing in mind the risks involved.
