If you are beginning your investment journey, indices trading might be the best option as it’s not a high-risk venture like individual stocks. Trading stock market indices is also the best way to gain exposure to the financial markets without in-depth research. Index trading involves buying a compilation of several shares.
Understanding Trading Indices
Trading indices exposes investors to an entire sector by investing in a single position. This is because indices measure the price performance for a collection of shares from an exchange. The best part is that you can speculate about indices’ price rise and fall without even owning any underlying asset with CFDs. Indices are highly liquid, have more trading hours than other markets, and expose you to many potential opportunities.
Calculating Stock Market Indices
The majority of stock market indices are calculated based on the market capitalization and the price weighing formula of the component companies. However, market capitalization is the most used method to determine how much the company’s stock is worth in total. To get the market indices, you need to multiply the number of outstanding shares with the current market value of a single stock.
Market capitalization = Current market price x Total number of outstanding shares
When is the Best Time for Trading Indices
There are certain times within the week when the market volumes and prices turn wild when index trading. Several factors, such as the news and events since the previous close, affect the market. Thus, if you are a seasoned trader, you must be on between 9.30 to 10.30 am. You must also note that different indices are traded at varying times, depending on the time zone. However, you should avoid trading during these peak hours if you are new as there is high volatility. And since they are not open 24/7 like forex trading, you must trade when they are open. Therefore, find the time that fits you best.
There are various types of trading indices, and these include:
- Commodity Indices
These consist of a group of commodities, such as raw materials, precious metals, and agricultural products.
- Bond Indices
These consist of various bonds from the bond market. A bond refers to a unit of government or corporate debt.
Synthetic indices are based on simulated markets and are referred to as a basket. Although they behave like fundamental financial markets, their price trends are created using randomly generated numbers through a secure computer broker. However, no broker has authority over these numbers, thus cannot influence the market outcome.
- Stock Indices
These are the most popular and most traded as they consist of a combination of stocks from top companies on the stock exchange. When you own indices, you don’t own any part of a company.
What are the Benefits of Trading Indices
Many people looking to save for retirement prefer trading indices to expose them to various companies. More so, if one company’s shares fall, others rally, meaning that diversifying your investment evens out in the event of extreme volatility.
Although the index value fluctuates during each trading session, it does not cause a significant change unless a significant event like a market crash, natural disaster, or political event happens.
It also poses a lower risk compared to investing in individual stocks. For instance, if you invest in a company and it later declares bankruptcy, you lose your investment, but if a company in an index group folds, it is replaced by the next large company. This may or may not have a considerable effect on your investment.
The downside of trading indices is that the returns are lower than those you’d have received by trading in individual stocks despite having a higher risk.
So, why should you invest in indices
- Lower risk
Since it’s a collection of stocks from different companies, it is rare to incur a loss or gain of more than 10% unless it’s a major disaster such as the COVID-19 pandemic which saw a 37% drop of the DJIA between February and March of 2020.
- No risk of losing all your investment due to bankruptcy
Unlike investing in individual stocks where you lose all your money when a company goes bankrupt, trading in indices will never leave you bankrupt. If one company goes bankrupt, it is replaced by the next company on the list of leading companies.
- Diversification
It allows you to diversify your investment rather than investing in one company’s stocks. For instance, when you invest with NASDAQ – 100 Index, you get to invest with the top American high-tech companies.
- Least manipulative
The index value depends on the price fluctuation of the companies that make that index.
The 5 Most-Traded Indices Include:
The firms in this index mainly consist of technology, consumer services, and health care companies. These are companies with the highest value.
- The S&P 500
This is among the most popular indices consisting of the S&P and Dow Jones Indices and regulated by the US Index Committee. For companies to be eligible, they must meet specific requirements, such as revenue, liquidity, and share float. And they must be consistent; otherwise, they are removed.
- Hang Seng
This is the largest trading index in China and comprises of the most prominent corporations listed on the Hong Kong Stock Exchange. By the end of 2021, it consisted of 58 companies, and it is estimated that in mid-2022, it will have about 100 companies.
- FTSE 100
Financial Times Stock Exchange comprises the 100 largest companies listed on the London Stock Exchange. FTSE is an essential indicator of UK businesses’ performance.
- DJIA
The Dow Jones Industrial Average is the oldest index globally and it was founded in 1986.
Risk Warning
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.
