Indices Trading Guide

Richard Montana | October 21, 2022

What are Indices?

Indices are a measurement of the price performance of a group of shares from an exchange. For example, the FTSE 100 tracks the 100 largest companies on the London Stock Exchange. Trading indices enables you to get exposure to an entire economy or sector at once, while only having to open a single position.

There are indices for almost every conceivable sector of the economy and stock market. Many investors are familiar with these indices through index funds and exchange-traded funds whose investment objectives are to track the performance of a particular index. Some of the most widely followed indexes include:

  • The FTSE 100: Sometimes called the ‘UK 100,’ this represents the UK’s hundred biggest companies by market capital
  • Dow Jones: Often referred to as simply ‘Wall Street’ this index is the price weighted average of 30 of the most significant stocks that are traded on the NASDAQ and New York Stock Exchange (NYSE)
  • S&P 500: The value of the Standard & Poor 500 is based on the share prices of 500 leading US-based companies
  • The DAX: Referred to as the ‘Germany 30,’ this index is made up of 30 major German companies
  • NASDAQ 100: The ‘US Tech 100,’ is a capitalization-weighted index made up of over 100 tech companies in the US
  • Nikkei 225: Japan’s biggest price-weighted index is comprised of 225 of the country’s biggest companies
  • CAC 40: Simply referred to as the France 40 this comprises 40 of France’s biggest companies by capitalization
  • Euro Stoxx 50: This index collects together 50 of the largest European companies’ share value

The three most popular stock indexes for tracking the performance of the U.S. market are the Dow Jones Industrial Average (DJIA), S&P 500 Index and Nasdaq Composite Index.

These well-known Indices are essentially baskets of individual Shares which are often ranked by independent institutions like major banks or specialist companies like Standard & Poor’s, the FTSE Group and Deutsche Börse.

It is worth keeping in mind that major shifts in the fortune of a single big company which is part of a wider index can have a potentially disproportionate impact on its performance.

What Moves the Price of Indices?

Indices price movements and volatility are impacted by factors like political events, major factors which affect companies in a particular sector, economic data such as employment figures and big changes in the foreign exchange (currency) markets.

It is worth bearing in mind that major shifts in the fortune of a single big company which is part of a wider index can disproportionately impact on the overall performance of an index. One leading index is the S&P 500, which reflects the collective value of the top 500 companies listed on US stock exchanges. If the overall value of those companies’ shares rises, the price of the S&P 500 will go up.

Global Indices markets are dominated by what are commonly referred to as “benchmark Indices”. These are the stock indices which have an outsize impact on economies and are generally held as overall indicators of the economic health of a particular country or area.

What is Indices Trading?

Indices trading means that you are taking a position on a stock index – which is measure of the performance of several different companies. Indices trading can be a way to get exposure to an entire sector or economy at once, without having to open positions on lots of different shares.

One of the most popular way to trade indices is via CFDs, also known as Contracts for Difference. These financial instruments allow traders to profit both from rising and failing markets.

CFD index traders would open long (buy) positions, if they think an index will rise or short (sell) positions if they thought that the index will fall. The difference in price between the entry and exit price is the traders realised profit or loss, excluding any broker commission and fees.

For example, a trader could place a buy order on the S&P 500. If the price of the S&P 500 index goes up, when the trader comes to sell, they will earn the difference between the buy and sell price. If the price of the S&P 500 index goes down, the trader pays the difference and makes a loss.

Some choose to take quick intraday trading opportunities, others prefer short-term swing trading methods, while others prefer long-time frames lasting weeks or even months. You should trade indices in a way that meets your own individual trading style and goals.

How does Indices Trading Work?

The most popular way to trade indices is via CFDs (contracts for differences). These financial instruments allow traders to profit from both rising and falling prices without actually owning the underlying asset or stock index in this case.

Traders would open long (buy) positions, if they think an index will rise or short (sell) positions if they thought that the index will fall. The difference in price between the entry and exit price is the traders realised profit or loss, excluding any broker commission and fees.

For example, a trader can place a buy order on the DAX 30. If the price of the index goes up, when the trader comes to sell, they will earn the difference between the buy and sell price. If the price of the index goes down, the trader pays the difference and makes a loss.

What is an Indices Broker?

An indices broker is a firm or an individual who executes orders to buy or sell indices on behalf of the clients and charges them a commission fee. A firm or individual who trades for their own account is called a trader. Indices can be on spot markets, futures contracts, options contracts, spread bets, CFDs (contracts for differences) and ETFs (exchange-traded funds).

Why Trade Indices?

Indices trading is a popular product for some traders for a variety of reasons. These include:

  • Speculate long or short on rising or falling indices prices
  • 24-hour trading
  • Way to diversify a trading portfolio
  • Trade indices with leveraged positions

Trading indices is a balanced way to trade on the world’s top financial markets without having to analyse the performance of an individual company stock as they offer exposure to an entire industry. Investors do not have to perform thorough research on individual company reports; they only need to take a bullish or bearish position on a stock index, depending on the overall market sentiment.

Trading global indices with an online broker enables traders to go both long and short on price movements in major indices from around the globe including the UK, US, Asia, Australasia and Europe.

Indices traders can benefit from market movement across not just a single sector, but a wide variety of different types of companies, providing ample trading opportunities along with the potential to diversify their portfolio and potentially reduce the overall risk of exposure to extreme volatility.

The price movement of indices can also be smoother as no one individual stock is likely to induce an extreme price spike, although of course anything can happen in trading. This naturally makes index trading less volatile.

That being said, due to the amount of activity that takes place on individual stocks, indices can still offer sufficient volatility for active traders to find trading opportunities according to their own individual trading strategies. This can be especially true for day traders and news-based price action followers since indices often reflect the broad economic effects of both political and economic shifts.

For the longer-term investors, index trading can be an easy way to diversify their portfolio. Instead of investing in just a few stocks and multiplying risk, index-based exchange traded funds (ETFs) can offer exposure to the entire stock market, whilst simultaneously reducing the risk of a single company negatively impacting an entire trading portfolio.

Most brokers will offer leveraged indices trading which can magnify the size of your trades without committing large amounts of capital upfront. For example, leverage of up to 1:20 allows you to start trading indices with as little as $100 whilst being able to manage $2,000 of capital ($100 x 20 = $2,000).

Whilst this can increase potential profit, leveraged trading also greatly increases risk. It is imperative that you have a full understanding of what leverage is and the significant risks involved with trading leveraged positions.

Choosing an Indices Broker

There are various factors worth considering if you are looking for a indices broker to trade online with. In this section, we will cover what we consider to be some of the most important factors that you need to be aware of when choosing a suitable indices broker for your own individual needs.

Regulation

If you are looking for a broker to trade indices online with, then regulation should really be one of the first things that you look for. Regulation is very important as it can give traders some protection in the case something was to go wrong. Regulated brokers must follow strict rules and procedures that are put in place to protect investors. Without regulation, there may be no help should the worst happen.

Indices

There are approximately 5,000 U.S. indexes. The three most widely followed indexes in the U.S. are the S&P 500, Dow Jones Industrial Average, and Nasdaq Composite. The Wilshire 5000 includes all the stocks from the U.S. stock market.

There are approximately 70 times more stock market indices than listed stocks in the world. There are nearly 3.3 million stock market indices around the world, according to research from the Index Industry Association (IIA).

If you have a particular index in mind, you will need to ensure that the broker you are considering has that index available to trade. The more indices there are, the more choice you will have if you wish to branch out in the future. You might want to see what other instruments are available including Forex, Commodities, Cryptocurrency, Stocks, Indices, Options, ETFs, CFDs and Futures.

Fees

Brokers will often charge a commission fee for processing your indices trades through their platform. There may also be accounting fees and inactivity fees. It is important to be aware of all the broker fees and compare brokers to make sure they are providing good value. If you are looking to save as much as possible on your trading costs, you can take a look at our best discount brokers.

Platforms

To trade indices online, you will need an indices trading platform which the indices broker will provide you with. There are various desktop, web and trading apps available, some more user-friendly than others. Each platform will have a choose of trading tools, features and functionalities. If you are already familiar with a specific trading platform, you may wish to check that the broker provides it. Alternatively, you can opt for a popular and user-friendly indices trading platform such as MetaTrader or cTrader. You will find that there are lots of MetaTrader brokers which is one of the most versatile platforms that gives convenient market access for manual and automated trading strategies. If you don’t have the time or skills to trade and want to copy trading signals, you should look for a social trading platform.

Leverage

In finance, leverage refers to the act of magnifying positions in the indices market through the use of borrowed capital. You have to qualify for a margin account, but when you do, you’re able to use leverage (margin) to get into indices trades. Leveraged products, such as indices CFDs, magnify your potential profit but also your potential loss.

For example, if you had an account balance of $4,000 and leverage of 1:5, you would be able to take a position size of $20,000 ($4,000 x 5 = $20,000).

Whilst this does mean that you can control a position size larger than you would have been able to without leverage, it also means the risk is significantly greater. It is imperative that you have a clear understanding of leverage and how it works before trading with leveraged positions.

Education

The best indices brokers should have a generous selection of educational resources such as trading guides, tutorial videos, webinars, eBooks, quizzes and more. These can help you to learn more about trading indices online and to help familiarise yourself with the brokers products and services. We are a big advocate of brokers who support informed trading. If you are new to trading and need as much guidance as possible, you might want to explore our best brokers for beginners.

Tools

Most indices platforms will have an array of built-in trading tools to assist with their daily trading activities and thorough market analysis. However, if you require any additional tools, it may be worth checking that they are provided by the broker. Tools can include economic calendars and earning reports to keep up to date with the latest index news, which can be used as part of a fundamental analysis. Other trading tools may include trade calculators, trading signals, market alerts and more.

Signup

Each indices broker will have its own minimum deposit policy so check that you can meet this requirement. You may also need to provide some personal information in order to pass the brokers KYC and AML procedures. The sign-up process can be quicker at some brokers, especially if all of it is conducted online. During the sign-up process it is very important to make sure that you read all of the brokers terms and conditions, only proceeding if you understand and agree with them.

Funding

Indices brokers can have a variety of different account funding options in order for traders to make deposits and withdrawals to and from their trading account. You should make sure that the broker has a convenient funding options for you along with the time taken and fees involved. Common broker payment methods can include wire transfer, credit/debit card whereas some brokers will offer online payment methods such as Neteller, PayPal and Skrill.

Support

There are indices brokers located throughout the globe. Some will offer email and telephone support whereas others will also offer live chat support. You want to be able to contact the broker at a time and via a method that suits you. Therefore, it can be important to check where the brokers’ offices are located, what times they are available and how they can be reached. You could test their response time and quality prior to opening an account.

How to Trade Indices Online?

If you have taken the time to read through the above, you should hopefully have an understanding of how to trade indices. Here is a summary of the key steps:

1. Decide if indices trading is for you

Trading indices online carries an element of risk and can take more time than other forms of investing. You will need to research indices, manage your indices positions, follow market news and decide how to react to it. It is important to understand the risks and dedication that comes with trading indices online.

2. Educate yourself

Before trading indices, it is imperative to learn as much as possible about investing and stock indices. Any mistake could prove to be costly. There is an abundance of free educational materials provided by many online indices brokers that can help you to improve your trading skills and knowledge.

Most indices brokerages will also provide a free demo trading account so that you can practice trading indices online with virtual funds in order to familiarise yourself with the trading platforms and practice your trading strategies until you feel confident enough to open a real trading account.

3. Choose an indices broker

In order to trade indices online, you will need a broker account and trading platform to execute your trade positions. When choosing a broker, there are a few important things to consider such as regulation, commission fees, platforms, tools, education, funding options and customer support.

4. Research indices

If you have made it this far then you may be ready to start trading indices online! The next step is to research the different companies to discover which indices you have an interest in trading. Perhaps there is a particular industry, product or service that is already of interest to you. Many brokers will allow you to filter indices according to various criteria in order to narrow down your search if need be.

Many traders will begin by analysing different companies, studying public information such as finances, earnings and reports from professional analysts. The best brokers should have this information conveniently displayed for you within their trading platform.

5. Have an indices trading plan

Some of the most important factors that can help determine your results when trading indices can be the trading plan and discipline. It is important to have a solid trading plan personalised to your own needs that includes the money management and trading strategy that you will use. Most experts and professional traders would try to not let negative emotions such as fear, anger and greed affect their trading strategy.

6. Buy and sell indices

Once you know what indices you want to trade online, you can analyse them to help decide if and when you will place your trades. After placing a indices trade, you will need to keep track of how it performs and manage it according to your indices trading plan. Some investors will keep hold of indices for the long-term, whereas traders may buy and sell stocks on a daily basis.

Conclusion

Trading indices is a balanced way to trade on the world’s top financial markets without having to analyse the performance of an individual company stock. Indices are financial derivatives that are calculated as a weighted average of share prices of the top performing companies listed on the exchange. Indices trading can be an effective way to diversify against risks by investing on a wide-ranging basket of assets instead of a few investments.

Now that you have had a brief overview of what indices are and what to look for when choosing an indices broker, you may be considering opening an online trading account to trade indices online. To do so, you will need to choose a broker, follow the account opening process and you will then be able to start trading indices online through one of their indices trading platforms.

However, it is important to understand the significant risks involved with indices trading, especially when using leveraged positions. Most experts would suggest trading on a demo account with virtual funds to begin with.

This can be a useful way to familiarise yourself with how to trade indices and use the trading platforms whilst allowing you to practice your trading strategies until you feel confident and produce consistent results. Most trading brokers provide unlimited demo accounts free of charge.

Take your time to research brokers and do your own due diligence, the above information is only for educational purposes and not advice. Please feel free to view our best indices brokers if you need some further inspiration before you get started.

About the Author

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Richard Montana
Richard has many years of experience in broker research, testing, analysis and reviews. He knows what to look for through years of trading himself with different brokers and listening to the feedback of others.

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For all of our broker reviews, we research, validate, analyse and compare what we deem to be the most important factors to consider when choosing a broker. This includes pros, cons and an overall rating based on our findings. We aim to help you find the best broker according to your own needs. You can read more about our review process.


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