HOW TO TRADE INDICES

INDICES
TRADING
EXPLAINED

Ian

HOW TO TRADE INDICES

INDICES
TRADING
EXPLAINED

Ian

If you’ve ever watched the evening news, you might have noticed a quick reference for the closing prices of major stock market indices around the world (usually before or after the weather forecast!) – but what exactly are these indices?

Indices (plural of ‘index’) track the performance of a specific group of stocks. This group of stocks either belongs to a particular market sector or represents a whole market (exchange).

For instance, the Dow Jones Industrial Average index tracks the performance of 30 companies listed on various US stock exchanges. The DAX 30 tracks the performance of the 30 largest companies listed on the Frankfurt Stock Exchange (FSE).

An index goes up in price if the overall value of the stock shares increases and down in the event the overall value of those shares fall. 

What is the difference between market-weighted and price-weighted index?

In a price-weighted index, the stocks with the highest prices have the most influence, regardless of the underlying company’s size.

In a market-weighted index (also known as a cap-weighted index), the stocks with the highest market value impact the movement of the prices.

Indices basket

THE MAJOR INDICES

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The word “industrials” in the name of the index no longer echoes its original architecture. Several of the present companies forming the index operate in sectors of the economy other than heavy industry.

Although it is one of the most followed equity indices, many traders believe that the Dow is a poor representation of the overall U.S. stock market. Compared to broader market indices, such as the S&P 500 Index or Russell 3000, DJIA includes only 30 large-cap companies. But let’s be honest: these 30 companies are the most influential.

The price-weighted US index seems to be pet-friendly too. Dogs of the Dow is an investing strategy related to the index. The general idea is to invest in the ten highest dividend-paying, blue-chip stocks among the 30 components of the DJIA.

Blue-chip stocks are shares of large and well-established companies with an excellent reputation.

S&P 500 is the most widely known stock market index. It is weighted by market capitalisation and is a benchmark of the US equities in the US economy’s leading industries. The index tracks 500 large-cap US stocks from companies circulating $5 billion or more in the stock market, including the 30 DJIA stocks. Like the Dow, it represents the stock market’s performance.

As with other indices, the S&P 500 is extensively used as a benchmark in determining a stock's investment performance and the best indication as to the health of the overall US stock market and economy.

S&P 500 makes up most of the market (about 80% of the overall market's value), while Its 10 most significant components comprise more than 21% of the Index.

The DAX 30, otherwise known as GERMANY 30, contains 30 German stocks listed on the FSE and is weighted by market cap. DAX 30 is one of the blue-chip stock indices, including FTSE 100 in the UK and the S&P 500 Index in the US.

DAX has followed the trends of other indices during significant events throughout history, including the COVID-19 pandemic. The German index also plunged in 2008 amid the global economic crisis.

The FTSE 100 tracks the 100 largest public companies by market cap listed on the London Stock Exchange (LSE). FTSE stands for Financial Times and the LSE, which initially formed the joint venture of being the index’s owner.

The Footsie, as investors love to call it, represents more than 80% of the LSE's market capitalisation. The UK 100, born in 1984, is the UK’s answer to the US Dow Jones. Its components are reviewed quarterly.

The NASDAQ 100 looks at the 100 largest non-financial companies’ market capitalisation, both domestic and international, listed on the Nasdaq stock market. There is a unique Nasdaq index hosting the financial companies named NASDAQ Financial 100.

Both of the above indices are sometimes confused with the Nasdaq Composite, i.e., “the Nasdaq”. Nasdaq, along with the Dow Jones and the S&P 500, are the three most broadly followed indices among the 5,000 indices of the US equity market.

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ALL YOU WANT TO KNOW ABOUT INDICES

HOW-WHY-
WHEN-WHAT

Indices icon

HOW TRADERS
USE INDICES?

Indices are a popular investment option since they offer exposure to a basket of stocks which, typically, the average trader would not be able to afford.

Apart from index trading, traders use indices:

Advantages icon

ADVANTAGES OF
TRADING INDICES

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Popular
Trade times

Affects icon

WHAT AFFECTS
STOCK INDICES?

As with all stock prices, the value of an index itself is affected by the performance of the companies’ constituents and macroeconomic factors. Indices react directly to major global or regional political, market and economic events such as interest rates, market expectations or even natural disasters.

Friendly reminder: The trend is not your friend. Seeing how indices have already performed — ie, the ‘trend’ — will not help you speculate on how indices will perform in the future. For example, if Dow Jones has been climbing for the last three weeks, this does not mean that it will continue to do so forever.

Indices icon

HOW TRADERS
USE INDICES?

Indices are a popular investment option since they offer exposure to a basket of stocks which, typically, the average trader would not be able to afford.

Apart from index trading, traders use indices:

Advantages icon

ADVANTAGES OF
TRADING INDICES

Clock icon

Popular
Trade times

Affects icon

WHAT AFFECTS
STOCK INDICES?

As with all stock prices, the value of an index itself is affected by the performance of the companies’ constituents and macroeconomic factors. Indices react directly to major global or regional political, market and economic events such as interest rates, market expectations or even natural disasters.

Friendly reminder: The trend is not your friend. Seeing how indices have already performed — ie, the ‘trend’ — will not help you speculate on how indices will perform in the future. For example, if Dow Jones has been climbing for the last three weeks, this does not mean that it will continue to do so forever.

HOW EUROTRADERS
CAN TRADE INDICES?

By taking a CFD position, a trader is essentially agreeing to exchange the difference in price of an index from one time period to another. CFD trading also allows traders to take advantage of leverage; with it, traders can open a trade with just a fraction of it’s total value, or in other words, less upfront capital. However, leverage much be approached with caution. While it can magnify a trader’s gains, it can also magnify their losses.

Traders can go either long or short on an index:

Short Long Image

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Risk warning: FX and CFD trading involves a high risk of loss. You should consider whether you can afford to take the risk of losing your money.

Risk warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 74-89% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.

Risk warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.

Risk warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 74-89% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.