Instead of trading individual stocks, many traders choose to instead trade using groups of stocks called an index. Each index represents a different section of the stock market, and their value is based on the value fluctuations of the stocks that make up each individual index.
In contrast to regular stock trading, index trading is fully speculative, meaning no actual assets exchange hands. Traders don’t trade indices directly – they instead use derivative instruments like spread betting, futures, options, and CFDs.
What are indices?
Each index shows how a certain group of stocks performs overall, creating a portfolio for traders to spot how well a given segment of the market is growing. The FTSE 100 Index, for example, shows the overall performance of the 100 publicly traded companies on the London Stock Exchange with the highest value, acting as an indicator for the UK’s stock market as a whole.
Each index features its own method for calculation, with all of them using complex mathematical formulas to achieve a final value. While a trader can’t directly purchase or sell indices, index funds are created using mutual funds and ETFs to mirror the fluctuations of a given index, giving traders a security to buy and sell that closely follows the value of that index.
Some of the most popular indexes you should keep an eye on are FTSE, S&P, Euro Stoxx, and Dow Jones.
Why is index trading becoming so popular?
Spread betting and CFDs are two popular ways of making profit on index fluctuations, along with other derivative financial instruments like options and futures. The simplicity of these instruments made index trading popular and accessible – simply open an account on a secure online trading platform of choice to start trading. While each of these instruments works in a slightly different way, they all give traders an opportunity to use leverage when trading indices.
Leverage allows traders to make large financial moves while only paying a fraction of their full value. With a 1:50 leverage, a trader could make a speculation on £5,000 worth of index stocks, while only having to pay £100 to open their position.
Leverage isn’t the only reason why index trading is so popular. The margins on index stocks are usually lower than on individual stocks, and they also offer less volatility. There’s also much lower risk of liquidity problems, as is often the case with individual stocks.
It’s important to remember leveraged trading comes with risk as it can amplify potential losses and in some cases, it’s possible to lose more than you invest. Consider using stop-loss orders or guaranteed stop-losses to manage your risk.
How to speculate on price movements?
While there is a lot of research involved in tracking index price movements, just like in the case of traditional stock trading, there is usually much less randomness involved. Since many indices track the overall performance of hundreds of growing companies, they’re less likely to suddenly fall in value.
Because of this, traders often use indices for hedging, reducing the overall risk of losing money on their long-term trading strategy. There are many indices available for traders to speculate on the world’s most valuable companies, like the DAX Stock Index for German and Swiss companies, or the CAC 40 for French stocks.
Speculating on index price movements is an advanced trading strategy and requires a good understanding of the stock and index markets. You can make profits on betting that a certain index either raises or falls in value, but you’ll still have to do your research to have a better idea of what to expect. Apart from reading and listening to the latest news, you can also try to follow advice from expert traders – but, just like with stocks, be careful of hype and always approach trading tips with scepticism.
Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. The vast majority of retail client accounts lose money when spread betting and/or trading CFDs. You should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money.