Indices Trading and How It Works

When it comes to the different trading instruments available today, indices have become popular.

Indices have a unique appeal, with their ability to give exposure to a wide range of companies and even an entire sector or economy at one time.

The feature that sets indices apart from normal stock is that you don’t have to open positions in a large number of different individual shares. It is no surprise that the interest in trading indices continues to grow, especially when you can gain access to the most liquid indices in the world.

As with all types of trading and investment, it is important that you are fully aware of both the risk as well as the benefit that indices trading can bring.

What are indices in trading?

Indices in the simplest terms are a measure of the price performance of a selected portion of shares or all the shares listed on an exchange.

For example, the S&P/ASX 200 index is a market capitalisation weighted and float-adjusted stock market index of shares listed on the Australian Securities Exchange. This list includes the largest individual companies such as Rio Tinto, CSL and the BHP Group.

In the case of selected shares, these may relate to a specific industry or from a number of different industries.

There is a special equation used for ranking each company relative to their market value. The calculation is made by multiplying the market price with the entire number of tradable shares. By trading an index, a trader can gain exposure to shares with the highest capitalisation on that exchange.

The popularity of indices trading is in how it allows traders to gain exposure to financial markets without the need to cherry-pick and invest in individual company shares, commodities, or bonds. Rather than buying or selling individual company shares, someone new to trading can utilise index trading where they trade an index-tracking fund or a basket of shares.

The aim of this option is to track how a large group of shares performs. With a stock index, you get a more big-picture representation of the state of the broader market, a specific sector or the overall stock market.

Each of the major financial markets in the world has at least one stock index which represents it. These indices demonstrate the performance of the overall stock market. The health of the specific economy or industry sector is indicated in the movement of the benchmark’s value.

The difference in volatility between indices and individual shares

Indices are different from individual shares, as any fluctuations are across the wider market (or a basket of assets) rather than on a single company. This means that the factors that affect an individual company may be specific to that company alone.

There are, of course, significant risks with any investment and you need to be aware of those risks ^[1]  rather than simply concentrating on the potential rewards. As noted by the ASX – ASX – ‘Asset prices can rise and fall rapidly and investors must accept the fact that the value of their index based investment may fluctuate by as much as 50% or more in a year.’ ^[2] General market risk can relate to a particular sector, where the example of mining sector indices are often more volatile than indices in the industrial sector.

The possibilities of market changes give you a wide scope for trading options. For instance, you could trade on the Dow Jones Industrial Average taking a fall or on the UK’s FTSE 100 doing well.

There are CFDs now available to cover the key indices from around the world. This means a trader in one country is able to participate in different global markets. Besides the SPI200, the UK and US markets, CFDs also cover the German DAX40 and DAX40ft, the Nikkei 225 and a long list of others.

There are important things to remember such as the example that the German DAX is considered more volatile than the FTSE^{[3]  [4]} and therefore offers increased rewards but at higher risks.

Whatever your market of choice, there is a correlation between FX markets and stock indices.

Access to the market

It is now possible to trade an index using futures or options contracts, exchange-traded fund (ETF) or Contract For Difference (CFDs). A Contract-for-Difference or a CFD on a share index allows you to speculate on the price movement of that index without actually owning it. Whichever index you want to trade, you need to have both a thorough and well-defined trading strategy before you open a position.

To learn more about what Indices trading can offer you, there is valuable information available about Indices CFDs Trading in Australia.

The prices of all Vantage Indices CFDs are based on the underlying price of the index’s corresponding stock market. Traders get the advantage of the competitive pricing.

How are stock market indices calculated?

Indices can be calculated in different ways. Many calculations are based on the types of companies being tracked and the goals of the index.

Some index calculations give more weight to those shares with higher prices, whereas others base the weighting on market capitalisation. Others may equally weigh all the constituent shares.

A big majority of indices are based on baskets of blue-chip securitie>>s on that exchange. This is usually held to be a strong measure of the current market situation.

The right place to start

With all the intricacies involved in indices CFDs trading, it’s worth engaging a broker who is regulated, offers fast trading execution and has a recognised trading eco-system.

That’s where Vantage prides itself on.

Vantage is a global, multi-award winning and multi-asset broker headquartered in Sydney. When you trade with us, you can be sure you have a dedicated team to assist you with your trading journey with Vantage.

Learn more about indices CFDs with Vantage or you can download the Vantage App now. If you want to get your trading started today, it only takes a matter of minutes to try our special Demo Trading Account or to Open a Live Account.

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