What are indices?
What are indices?
Trading indices is an opportunity for retail traders to secure exposure to the financial markets, without having to invest in the leading equities individually. An index is a collection of equities or assets, whose values rise and fall based on the collective performance of the shares or assets included.
To calculate the market value of an index, many indices will use something known as a ‘weighted average’. Therefore, the equities or assets with the highest market capitalisations or share prices will carry a greater weighting in the value of the overall index. That’s because these high-cap equities or assets are more likely to have an effect on the wider industry or economy that the index represents.
Some indices may also take the ‘equal-weighted’ approach, with all equities or assets within an index given equal value.
Why traders trade indices
One of the biggest benefits of trading indices is considered to be diversification. The theory is that by diversifying and spreading your risk across a cluster of equities or assets, you are evening out the potential extremes in volatility.
Indices, therefore, pose a lower-risk option than if you were investing in individual equities as your exposure is spread across multiple companies or assets. We’ve put together the pros and cons of indices trading to help you make a more informed decision:
Pros of indices trading
- Diversify your exposure in the stock market
- Indices are some of the least manipulative financial instruments to trade
- There is little to no risk of losing all your investment overnight, like the bankruptcy of a publicly listed company. If an individual equity goes bust and is listed within an index, it is replaced by the next company on the list of leading firms
Cons of indices trading
- When you buy an index fund, you have no control over the individual equities or assets housed within the portfolio
- Limited protection from the downside of index investing, with only breakeven strategies like buying put options against an index providing temporary solutions to market uncertainty or volatility
The different types of indices
There are seven types of stock market indices to look out for:
- Global indices
- A global index usually consists of stocks from various regions and industries worldwide. It can provide an accurate barometer of the global economy.
- Regional indices
- A regional index will contain stocks or assets exclusively from a particular region e.g. Europe or North America. The most popular regional indices are the FTSE Euro 100 Index and the S&P Asia 50 Index.
- National indices
- A national index will include stocks or assets solely from a particular nation e.g. equities listed on a nation’s leading stock exchanges. The FTSE 100 is the most common UK-wide index, while the DAX 40 is the most popular national index for German equities.
- Industry indices
- Industry-specific indices track the performance of equities within a defined industry e.g. technology or renewable energy. The Dow Industrials Index tracks the leading light industrial equities, while the US100 Biotechnology Index benchmarks the performance of the pioneers within biotech.
- Exchange-based indices
- These indices track the performance of equities listed on a specific stock exchange or a collective of stock exchanges. The Euronext 100 is an index that consists of the top 100 listed companies across all national Euronext exchanges.
- Currency indices
- A currency index monitors the value of a fiat currency against other leading fiat currencies around the world. The US Dollar Index is a benchmark for the global value of USD.
- Sentiment indices
- A sentiment index tracks investor sentiment in terms of the future direction of equity values. The Volatility Index (VXX) is a fair barometer for volatility and uncertainty in the stock markets.
The DAX 40 is a national index, covering the top 40 listed companies on the Frankfurt Stock Exchange (FSE). These companies are ranked based on their market cap and liquidity, making them a strong barometer of economic prosperity in Germany and western Europe.
Dow Jones 30
The Dow Jones 30, also known as the Dow Jones Industrial Average (DJIA), is an index of 30 prominent industrial firms listed on US stock exchanges. It is a price-weighted index, unlike many other market cap-weighted indices.
The FTSE 100 is the index of the top 100 listed companies on the London Stock Exchange. It is a market cap-weighted index, meaning the firms included are deemed the most valuable in the British economy.
The S&P 500 is said to provide a broad-based barometer for the economic performance of the United States. It tracks the performance of the US’ 500 largest companies and is, therefore, one of the most regularly followed.
Trading indices for beginners
1. Decide how you wish to trade indices – you can do so using either spread bets or CFDs. Both of which are financial derivatives that don’t require you to own the underlying assets to trade
2. Create a trading account with your chosen spread betting or CFD brokerage
3. Choose the index you wish to buy or sell
4. Set your stop-loss and take-profit orders to manage your overall risk in the markets
5. Keep an eye on your open position, but don’t overanalyse it – bringing too much emotion to the markets can hinder your approach. Let the stop-loss and take-profit orders handle your risk-reward ratio.
Next steps for budding indices traders
If you’re serious about honing your skills for trading indices, be sure to check out our additional resources on this subject matter:
What is CFD trading
Learn the dynamics and benefits of contracts for difference (CFDs) trading.
How to spot a FTSE 100 riser
Discover how to pinpoint potential risers and fallers in the FTSE 100 index.
Index CFDs at Skilling
Find out the leading index CFDs available to buy and sell with a Skilling account.
Top CFD trading tips for beginners
Get your hands on our top tips when creating your first CFD trading plan.
Not investment advice.