Contracts for difference (CFDs) are contracts between buyers and sellers which allow investors and traders to profit from a movement in price without owning the underlying assets. On the other hand, indices are a collection of underlying assets or markets, summed to produce one representative figure on which performance can be measured, tracked and compared against past performance of shares on an exchange. Examples of known stock indices include the S&P 500 and the Dow Jones.
Indices can also be used to predict future movements.
Index trading enables investors and traders to get exposure to an entire sector or economy with a single trade. This is in addition to allowing investors to diversify their portfolios.
Trading CFD indices offers a convenient and quick way to trade the overall stock market. By using a CFD, traders can trade stock indices without having to own stocks in the index.
Examples of popular index CFDs include US 500, Wall Street, Switzerland 20 and Germany 40.
So, why should one trade using CFD indices?
You can hedge your current positions
When shares start to lose value and the market enters a downturn, the short position on the index will increase in value, which offsets the loss from the stocks.
This means that an investor who has a collection of different shares can short an index to prevent themselves from incurring losses in their portfolio.
Investors who have short positions on different stocks that feature on an index can also hedge against the risk of any increase in price with a long position on indices. This means that if the index rises, their position will earn a profit, which counteracts the losses on their short stock positions.
Allows investors to trade with leverage
Trading with CFDs is basically leveraged trading, which means that traders only commit a small margin to open a position which affords them much larger market exposure.
It should be noted though that loss or profit incurred when trading with leverage is calculated using the position size, not the initial deposit used to open it.
You can go short or long
Trading CFD indices also allows traders to go short or long. Going short means selling a market with the expectation that the price will decrease. Going long means buying a market with the expectation that the price will increase.
A trader’s profit or loss when trading with CFDs is determined by the overall size of the market movement as well as their prediction’s accuracy.
How does one trade indices?
Decide whether to use CFDs for index trading.
For starters, one has to decide whether to use CFDs for index trading. CFDs are financial derivatives, and this means that traders can use them to speculate on indices which are falling or rising in value.
Choose an index to trade with.
Traders can then choose the index they are comfortable with. It is recommended that traders choose an index that best suits their trading style, while taking into account the capital available, their appetite for risk and their position preference.
Having some prior knowledge of the stock index one is comfortable with may make trading easier. You shouldn’t fret if you don’t though, because analysis, news and research can help learn how volatile price movements in these markets can be as well as identify what type of trading opportunities different indices provide.
Decide market to focus on.
There exist thousands of CFDs being offered on financial markets. Therefore, selecting the number of CFDs you wish to trade as well as deciding on which market to focus on will allow traders to plan for their next trade.
One should keep in mind that with equity trades, 1 CFD is equal to 1 share. However, when trading commodities, forex or indices, the value of 1 CFD is dependent on the instrument.
Decide whether to trade cash indices or index futures.
After this, traders can then decide whether to trade index futures or cash indices. Index futures are usually preferred by traders with a long-term market outlook as they are traded at the futures price.
Cash indices on the other hand, are preferred by traders with a short-term outlook as they have tighter spreads in comparison with index futures.
Set limits and stops.
These are crucial tools for managing a trader’s risk when trading CFD indices. A limit order will automatically close a trader’s position if it moves to a more favorable price while a stop order will close their position if it moves to a less favorable level than the present market price.
Open an account and monitor your trades.
When a trader is sure that they are ready to begin trading CFD indices, they can then open and account and begin. Staying on top of market movement by monitoring trades helps minimize potential losses and allows traders to lock in profits.
High-Risk Investment Warning: Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to trade foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial adviser if you have any doubts.