What Is Indices Trading And How Does It Work?

Indices are one of the most popular trading instruments. They allow investors to get market exposure to the entire industry or even economy, without having to trade company stock directly. Moreover, indices trading provides speculators with a potential opportunity on both rising and falling markets since they can open either long or short positions.
If you are considering adding this asset to your investment portfolio, but are confused about where to start from, read our article and find out what is special about trading indices, which indices are the most popular, how to trade them, and more.

What are Stock Indices?

A stock index is a measurement that helps traders evaluate the performance of a specific basket of stocks over some time. What’s more, it can serve as a benchmark of the economical situation in a particular region or country. For example, S&P 500 index provides performance information about more than 500 US companies, allowing investors to gauge the condition of the whole US stock market while having only one position opened. This way, if the average value of these 500 companies increases the index will go up, and conversely, if the average value of these companies decreases, the index will go down as well.

Types of Stock Indices

Based on their coverage, indices can be divided into seven categories:

1. Global indices represent the stock performance of various companies worldwide. Some of the popular global indices include the FTSE All-World Index, MSCI World Index, etc.
2. Regional indices help to analyze the performance of the stock market in a specific region, for example, Asia, Europe, etc. Regional indices examples involve FTSE Developed Europe Index, Euro Stoxx 50 Index, etc.
3. Country indices track the performance of the biggest companies listed on the national stock exchange. In Germany, it is the DAX 30 Index, in China - SSE Composite Index, in France - CAC 40 Index. etc.
4. Exchange-based indices are related to the stocks of a particular exchange or group of exchanges, for instance, NASDAQ-100, or Euronext 100.
5. Industry-based indices represent the stocks of the companies engaged in a specific sector of the economy. For example, the NASDAQ Biotechnology index tracks the companies, operating in the biotechnology sector.
6. Currency indices track the price movements of a specific currency. US dollar index measures the changes in the value of the US dollar, comparing it to the value of the basket currencies.
7. Sentiment indices track how a definite group of traders feels about the economy or the market in general. Some of the examples here include NYSE 200-day Moving Average, Volatility Index (VIX), and others.

How Are Stock Indices Calculated?

There are two common ways to calculate stock indices: market capitalization-weighted and price-weighted.

1. The market capitalization-weighted average is based on the market cap of the index component companies. This means, that bigger corporations have more influence on the index value than smaller companies. Market capitalization-weighted indices are more widespread and include S&P 500 Index, NASDAQ-100, and others.
2. The price-weighted average is based on the value for one share in each of the index constituents. It implies that companies with a higher price for their stock will have a greater influence on the index. This approach is not so common, however, is used to calculate the price of some popular indices such as the Dow Jones Industrial Average (DJIA).

The Brief History of Index Trading

The history of indices trading dates back to 1884 when the Dow Jones Transportation Average Index (DJTA) was created. It is the oldest of still-existing stock indices. Don’t confuse it with the Dow Jones Industrial Average (DJIA) often called Dow Jones, or the Dow calculated by Charles Dow and Edward Jones in 1896, which makes it the second-old stock index worldwide. Initially, the Dow was focused on the heavy industry field. However, in the course of history, it was changing and evolving. Nowadays the Dow consists of 30 blue-chip companies from all the major industries, except transportation and utilities.

In 1923 a Standard Statistic Company, which later merged with Poor’s Publishing, created its first market index. It consisted of 233 companies. In 1957 this number was increased to 500, forming one of the most popular indices nowadays - the S&P 500.
Both the Dow Jones and S&P 500 remain popular and widely used. However, many financiers consider the latter one more informative and accurate since it is market-value-weighted and has a bigger number of component companies.

What Are the Most Popular Indices?

The financial market offers investors a great variety of indices to trade. Only the US stock market comprises over 5000 of them. Some of the world’s major indices include NASDAQ-100, Dow Jones Industrial Average (DJIA), S&P 500, FTSE 100, the DAX-30, IBEX 35, etc. Let’s have a closer look at them.

NASDAQ–100

NASDAQ-100 is a market-capitalization-weighted index. It represents the 100 largest US and international companies, coming from different fields except for the financial one and listed on the NASDAQ stock exchange. Some of them include Apple, Google, Microsoft, Facebook, and others. 56% of this index is formed by technologically-focused companies, the second-largest share is represented by consumer service companies such as eBay, Booking Holdings Inc., and others. NASDAQ-100 is traded via the Invesco QQQ exchange-traded fund, which monitors the performance of index constituent companies.

DJIA - Dow Jones Industrial Average

The Dow is the second oldest index worldwide created in 1896. It represents the performance of 30 blue-chip publicly-owned US companies traded on the New York and NASDAQ stock exchanges. In contrast to other heavily-traded indices, it is weighted on the stock price of its component companies. This is one of the reasons why DJIA is often considered inadequate in comparison with other broader indices. The Dow is supervised by the Averages Committee, which selects the index constituent companies from different sectors except for the transportation and utilities. Some of the most popular names involve Coca-Cola, Disney, Nike, IBM, and others.

S&P 500

Standard & Poor’s 500 is a market-cap-weighted index that tracks 500 top publicly-traded US companies and captures about 80% of the available market capitalization. Being one of the broadest indices, it’s considered one of the most accurate and adequate tools to analyze the condition of the US stock market. Some of the index components include Apple, Amazon, Tesla, Pfizer, PepsiCo, and others. S&P 500 is supervised by the US Index Committee, which decides on the choice of component companies and manages the methodology.

FTSE 100 (UK100)

Financial Times Stock Exchange 100 represents the performance of the 100 companies traded on the London Stock Exchange based on their market capitalization. Some of the examples include AstraZeneca, HSBC, Shell, Tesco, etc. Many of FTSE 100 constituents are international. This means that despite being considered the UK major index, it is not a UK stock market benchmark.

DAX (GER30)

DAX is a market-capitalization-weighted index that includes the 40 largest german companies represented on the Frankfurt Stock Exchange. It can be compared to the US Dow Jones index and due to its rather small representation can not be always considered as an accurate German stock market benchmark. Some of its well-known constituent stocks include Adidas, BMW, Continental, Siemens, and others.

IBEX 35

This is Spain’s major market-cap-weighted index. IBEX 35 consists of 35 top companies traded on Spain’s main stock exchange called the Bolsa de Madrid. This index is governed by the Technical Advisory Committee that selects and reviews its composition. Some of the companies making up the IBEX 35 involve ACS, Almirall, Naturgy, and others.

Other Important International Indices

Here are some of the other most popular stock market indices.

• ASX 200 - is an Australian benchmark stock index. It represents the performance of 200 blue-chip companies. Some of them are the Australian Foundation Investment Company, National Australia Bank, etc.
• Nikkei 225 is a Japanese price-weighted index that represents 225 publicly-owned companies from various industries traded on the Tokyo Stock Exchange. Companies forming the index involve Sony, Nissan, Nikon, Canon, Osaka Gas, etc.
• RTS index is a Russian free-float market-capitalization-weighted index. It tracks the performance of 50 companies traded on the Moscow stock exchange. Its constituents include Aeroflot, Lenta, Lukoil, Gazprom, etc.
• Euronext 100 is an index used on the pan-European exchange - Euronext NV. It is based on 100 constituents, some of them are Airbus, Danone, Bic, Carrefour, etc.
• CAC 40 is a primary French stock index that represents the 40 largest companies traded on the Euronext Paris Stock Exchange. Here are some of the component companies: Airbus, Michelin, Renault, etc.
• Hang Seng is a capitalization-weighted stock index monitoring the performance of top companies presented on the Hong Kong Stock Exchange. The number of its components may vary, as for December 2021, they were 64. Some of its well-known examples are Xiaomi Corporation, Alibaba Group Holding, etc.

What Factors Influence Stock Market Index Prices?

Stock market indices price is determined by fluctuations in the value of the constituent shares. Therefore, primary factors, having an impact on it are the same that move the value of the assets themselves. Here is the list of the most important ones.

1. Political factors such as news, region stability/instability, political certainty/uncertainty, etc. have a great influence on the stock indices price. Since traders try to avoid unclear market conditions to mitigate their risks, negative political events (wars, conflicts, etc.) decrease the attractiveness of the shares and indices in the market.
2. Economic news related to the interest rates, level of unemployment, GDP, central bank announcements, etc. represents the general state of the region’s economy. Thus, positive economic data fosters the growth of the stock indices. And conversely, negative economic news leads to the indices price drop.
3. Company announcements such as annual or quarterly reports, merger news, etc. tend to have an impact on the company stock price and indices that have it as a component.
4. Investor sentiment implies that the feelings and expectations of some traders may persuade others to behave in the same way. If the stock prices are falling speculators tend to be more careful, which can negatively result in the index price. In case the stock prices are going up, investors become more active, fostering the growth of the index value.

Why Trade Indices?

There are several reasons why trading indices is gaining popularity in recent decades.

• Trading in either direction. Indices can be traded via contracts for difference (CFDs), which implies that it’s possible to open both short and long positions. If the index price is expected to improve traders can go long. In case the asset price is going to decrease in value they can go short and take advantage even of the falling market.
• Diversification. Indice trading provides investors with an opportunity to get access to the whole industry or economy while opening only one index position.
• Lower volatility. Indices are formed by a basket of stocks, so their price movements are balanced by the number of the constituent companies. It also means that trading indices could be less risky than trading individual stocks.
• Trading with leverage. CFD trading allows investors to trade with a different amount of leverage. It means that it’s not necessary to invest the total amount of the underlying asset to open the position. Traders have to pay only the margin (a small percentage of the total price). However, leverage should be treated with caution. It can lead not only to increased market exposure but also to amplified potential losses.
• Hedging. Indices trading is one of the efficient ways to mitigate risks. If a trader expects his stock to drop in the short distance, he can open a selling index position. This way, if his predictions are correct, the index trade will help him offset the losses from the main position. Alternatively, if the stock remains stable or even grows in value, an investor could profit from his main portfolio, potentially covering the loss in the index trade.

How to Trade Indices With NAGA?

Naga is an innovative and efficient platform to trade indices. Having an intuitive interface it’s really easy to get started with. All you have to do is to follow these steps.

1. Create a trading account with NAGA and log in. Go to naga.com and register your account. It won’t take you long, moreover, you will get a free demo account with $10000 virtual funds, so you can check out how it works or improve your trading skills.
2. Select the index you want to trade. The choice of the index depends much on the investor’s trading style, personality, risk tolerance, available capital, etc. The suitable index together with a robust trading strategy and risk management plan are core components of possible profitable trading.
3. Decide whether to go long or short. It’s reasonable to go long when you expect the market to grow. Alternatively, if the results of your research show that the market is likely to go down, you can open a short trade and profit from the index fall.
4. Set your stops and limits. Stop limit order is an effective tool in risk management. It potentially allows traders to limit their downsize loss or lock in profits. If the trade reaches one of these orders it is closed automatically.
5. Monitor and close your trade. Keep an eye on the asset price movements and close the position when reaching a desirable profit or if trying to avoid greater losses.