by Craig Erlam
Index trading — taking a position on stock indices — allows investors to speculate on the price movements of particular exchanges around the world. There is, of course, no foolproof method to predicting how markets will move, but understanding the key factors around trading indices is an important foundation. As Benjamin Franklin once said, “An investment in knowledge pays the best interest.”
Here are three key issues to consider when trading indices:
Research the composition and weightings of the index
Stock market indices each have their own criteria and approach to determining constituent stocks, and typically use a method of weighting to calculate their value. Common methods of index weighting include equal-weighting, market-cap weighting, and price weighting — each of which will have a different impact on the way the respective index performs.
Depending on the construction of an index, it can provide a snapshot of a particular industry. For example, the Dow Jones Industrial Average — perhaps unsurprisingly given its full name — was historically renowned for being heavily comprised of industrial companies. Today, the Dow Jones includes a wide range of industries, but the NASDAQ 100, for example, skews heavily toward the technology industry, while the France 40 lists a high number of luxury brands. Additionally, geographical exposure can vary: while the FTSE 100 is a UK index, a large majority of its revenue is generated outside of the UK, giving a far more global exposure.
Consider the potential impact of market-moving events
By their nature, indices can be susceptible to volatility. As trackers of entire markets and sectors, indices are impacted by a wide range of factors including economic news, geopolitical events and company announcements.
For example, prior to the recent rises in interest rates across the globe, the NASDAQ 100 had been outperforming compared to the Dow Jones and the S&P 500, as many US technology firms were experiencing high growth. However, when interest rates began to rise, many of those same highly-leveraged technology firms saw their value decline — resulting in a negative impact on the NASDAQ as a whole. Meanwhile, changes in the global energy markets stemming from the Russian invasion of Ukraine meant that at one point, oil and gas firms were performing extremely well as the price of a barrel of oil soared, which was reflected in indices with a high composition of energy firms.
Assess whether indices trading is a good fit for your goals
One of the biggest benefits of trading indices is the breadth of market exposure that you can gain from a single position. That can be particularly beneficial for less experienced traders, as indices offer an opportunity to quickly get exposure to markets without having to engage in the high levels of research often needed to invest in single stocks. That’s not to say that index trading is just for beginners, though — trading indices can be part of a diversification strategy with the goal of balancing risk. Using CFDs, you can go long as well as short, which can allow you to hedge against longer-term investments. You could, for example, short an index that is heavily weighted toward a particular industry while simultaneously being long on an individual stock within that same industry, so that you’re hedging yourself against the market as a whole.
Index trading may also be attractive to those looking for shorter-term opportunities, as it is an immediate way of speculating on the price movements of a total market and does not necessarily require long-term investment. Additionally, trading indices allows you to use leverage to control a larger position with a relatively smaller amount of trading capital.
Ultimately, while trading indices allows investors to take a position without having to conduct deep research into individual assets, there are a number of factors that need to be considered and understood first.
Click to find out more about trading indices with OANDA.
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.
76.6% of retail investor accounts lose money when trading CFDs with this provider.
You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
About OANDA
A trusted, regulated broker, OANDA offers competitive spreads on a wide range of CFD markets, including indices, forex, commodities, metals and bonds.
Voted “Most Popular Broker” by TradingView three years in a row in 2022, 2021, and 2020, OANDA is the broker of choice for traders who want a smarter way to trade.
Established in 1996, OANDA has affiliates in the world’s most active financial markets, including London, New York, Toronto, Singapore, Tokyo, Sydney and Warsaw.