Indices trading has quickly become a significant component in today’s financial industry. And perhaps because of this, many investors are now beginning to explore what trading indices can offer, and are taking advantage of this particular investment area.
However, before beginning your journey with indices trading, it is essential to know exactly what it is and how it works. Like any other form of trading, this process requires extensive knowledge to minimize risk and increase potential profits in your investments.
In this article, you can learn what indices are, how indices trading works, and why choosing indices trading might suit your portfolio. Read on to find out more.
What are indices?
In the trading world, indices (known alternatively as indexes) represent the value of a collective group of shares. Individual stocks can be grouped under particular criteria to form indices on any exchange.
Some examples of heavily-traded global indices are:
- Financial Times Stock Exchange 100 (FTSE 100) – represents the 100 largest blue-chip companies on the London Stock Exchange, measured by market capitalization
- Dow Jones Industrial Average (DJIA) – known as ‘Wall Street,’ represents the 30 biggest publicly-listed companies in the US, measured by price.
- Deutscher Aktienindex (DAX) – known as the ‘Germany 40’, represents the 40 biggest companies on the Frankfurt Stock Exchange, measured by market capitalization.
- NASDAQ-100 (NDX) – represents the 100 largest non-financial companies on the NASDAQ Exchange, measured by a modified market capitalization.
These indices all contain multiple stocks and are ranked using specific criteria. Indices trading will therefore take into account the performance of the entire index as a whole.
How does indices trading work?
The most common method of indices trading is through Contracts for Difference (CFD). This involves the purchasing of contracts (units) on a particular index, which stipulates whether you are opening a long (buying) or short (selling) position. While purchasing a stock outright would mean that you own the asset, buying CFDs means you can profit off of price movements without the responsibility of asset ownership.
For example, if you open a long CFD position on FTSE 100, and the value of the FTSE 100 increases, this is where you can make a profit on your investment. If the value decreases, you will potentially make a loss – opening a short position would’ve been more appropriate here.
Various factors can affect the price movements of indices, ranging from economic news and political events to sector changes and company restructuring. Every individual stock in an index is ranked according to its price/market capitalization). Therefore, which has a larger impact on the entire index value. You must be aware of these factors when planning your investments.
What are the advantages of indices trading with CFDs?
Trading with CFDs can often be a preferable form of indices trading amongst investors for many reasons:
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Collective exposure
Indices trading can provide immediate exposure to an entire index instead of individual stock trades. When an index has a price movement, the exposure on your indices trade can be huge since you’re speculating on the price performance of vital stocks on a single exchange. The alternative would be to open individual positions on every stock in the index, costing more money and time.
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No responsibility of asset ownership
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Trading indices with CFDs allow you to reap the potential profits of index price movements without the increased risk of owning the assets. This not only allows you to trade with significant stocks you may not be able to afford ownership on, but it also means you can profit on a value decrease, as well as an increase.
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Leverage trading
CFDs provide leverage trading, which can be a significant factor in your potential profits. You can put down an initial deposit then multiply based on the leverage ratio, letting you open a position at a greater market value than you can afford. This can mean bigger profits on your initial investment and multiplied losses. It’s worth noting that you will be liable for the entire value of the position, not just the amount you have put in.
There are many layers to trading with indices, but you can make it a valued component in your trading portfolio with the proper planning and approach.
