Table of Context

  • A guide to trading indices
  • What is a stock index?
  • How to trade indices
  • What are indices futures
  • Types of stock indices
  • What are some calculations bases for Indices?
  • How to Trade NASDAQ Index? Why trade indices?

Market Index tracks the overall movement of a list of assets in the market, chosen based on certain criteria. Its composition and category could vary depending on the market capitalisation and industry respectively. It usually shows a prevailing trend in a category of assets as a whole.

Index value is assigned to the established indices for the ease of trading and calculating variance. This is a very good benchmark for analysing the performance of a sector of market and evaluating the reasons of deviation.

What is a stock index

An index measures the performance of a group of securities with the intention of replicating a specific area of the market. A market index is a hypothetical portfolio that represents a segment of the financial market. In other words, index or market index is a listing of a segment or group of stocks on an exchange measure their overall performance based on analyses of and statistics related to the underlying stocks. The root meaning of the word index or the method of indexing is applied to compile the economic data in a metric or compare it with such a metric.

The basic difference between an index and an exchange is that an index groups certain listed stocks with specific market characteristics on the exchange, whereas an exchange is a platform where the stocks are listed and traded in. The main aim of building an index on the exchange, therefore, is to gauge the industry-wise outlook based on metrics such as price movement, market capitalisation and trend analysis of the overall market.

How to trade indices

Stock Index is a market index that tracks the movement in a hypothetical stocks’ portfolio, so as to have a holistic view of the chosen market segment. It allows an investor to speculate on a prevailing trend in the market without investing in any one stock. Trading a stock index is a safe way to trade equities, because even if one company in the group changes track, the others in the group keep the index value afloat. But it is also a risky market, and it may be suitable to more experienced traders who actively indulge in market research and analysis.

These types of investments are usually hedged against other safer investments such as money market instruments or balanced hybrid mutual funds, to keep a diversified portfolio of investment.

What are Indices Futures?

The Indices Futures market is a purely speculative market, as there is no intent to take delivery of any underlying stock or commodity. The only purpose of trading futures indices is to earn a profit from the trade itself. Index Futures show the investors perspective for a market segment based on its fundamental analysis, as well as future prospects of growth.

Due to a higher spread as compared to the cash markets, the overnight funding rate in Futures market is also high, which needs to be factored in. Below are some other things that need to be considered while trading in Index Futures:

  • Defining a risk appetite is one of the most important things while trading in any instrument and investors should strictly adhere to it.
    • Leverages should be set wisely as they may lead to higher profits as well as higher losses. Despite low margin deposits, the high leverage trading can lead to margin shortfalls as per end-of-day Index price.
  • The volumes traded in a market dictate the price volatility and the liquidity in the market, which is quintessential especially in speculative trading.
    • Open interest in a contract shows the volume of open trades in the market, which are attracting the interest, and an immediate change in price, that is the change in open interest represents a market move.
  • The investor should have good knowledge of the sector whose index they’re trading in. The better the knowledge, the more aligned will the investor be with the general market sentiment, and as a result potentially more possibilities of picking the right trend.
    • The government policy timelines should be followed to stay up to date with latest news and announcements.
  • Futures markets function on a long-term market outlook and so there can be a number of things that can go wrong to prove the outlook wrong. Hence, index funds can be traded for maintaining a balanced view on the economy.
  • Since the futures contracts are agreed to be settled on expiry, they pose an obligation on the buying party to settle the contract for cash, unless the contract is sold before the expiry.
    • Options contracts can be traded to learn the market movement and contract valuations, as they are cheaper, not obligatory and offer multiple expiry options.

What are the types of Market Indices?

The types of market indices may vary depending on the sector of the company, market capitalisation and benchmarking. There are as many indices in the market as there are sectors that the listed stocks belong to, which could vary from Information Technology, Energy to Banking, Pharma, etc. Apart from sectoral classification, there are also benchmark indices from advanced economies such as the S&P 500 Index (SPX), Dow Jones Industrial Average (DJIA) of USA, Strait Times Index on Singapore Exchange (SGX) and Financial Times Stock Exchange (FTSE) 100 Index on London Stock Exchange.

How are indices calculated?

Indices are broadly calculated based on the following two categories:

  • Market Capitalisation Method

Market Capitalisation is the valuation of a company’s outstanding stocks in market circulation. This method involves taking into account the total market value of a stock to assess to what extent it affects the overall value or movement of an index. This method implies that the more the market cap of a company’s stock, the more its influence on the index will be.

A company’s stock can be categorised as large, mid or small-cap based on the market capitalisation method. The value or definition of this categorisation may vary depending on the market economy in question. Some popular examples are NASDAQ Composite and FTSE 100.

  • Price-weighted Method

A price weighted index  refers to the per-share price of different stocks listed on the index.  To calculate the value of a price-weighted index, you first find the sum of the stock prices of the individual companies, and then divide by the number of companies. This method involves ranking a company’s stock on the index based on the price component of the shares rather than on the total outstanding shares, to gauge its effect on an overall value or movement of an index. This also tends to make the index more volatile and price sensitive. The implication of using this method is that highly-priced stocks have a stronger expression on the index.

Some popular examples are Nikkei 225 (Tokyo Stock Exchange) and DJIA.

There could also be some other basis for calculating weights on indices such as:

  • Revenue-weighting

As clearly derived by the name, the weightage under this method is based on revenues of the company in a specified period, to be used as a mechanism of ranking.

  • Fundamentals-weighting

The weightage under this method is assigned based on fundamental analysis of certain metrics in a company, to be used as a mechanism of ranking.

  • Float-weighting

To assign weights under this method, only the floating number of shares is considered against total outstanding shares, to be used as a mechanism of ranking.

How to Trade NASDAQ Indices on MT4

Indices are a great way to invest in a sectoral market as a whole, given the comprehensibility of the stocks it comprises and the benefit of going long and short based on the investor’s view of the market. Since the index market, similar to the forex market, is a 24/7 market, the volatility can be speculated for when the relevant news influx is more. As we know, many factors affect the price movement in an index, so it is crucial to understand these influence factors and use them appropriately while getting into a trade. This analytical feature is provided by MetaTrader 4 (MT4) platform.

The MT4 platform was launched in 2005 by MetaQuotes and has been significantly famous for forex trading. Besides forex, MT4 allows trading in a range of markets such as indices, stocks, cryptos and much more. The reason for the popularity of MT4 is its highly customisable offerings as per investors’ needs and an exquisite, automated trading experience. It operates through different brokers (agents) worldwide, who can be chosen as per their respective feasibility.

How to Trade the NASDAQ Index?

The US stock market is the benchmark marketplace for the best of tech stocks, existing and upcoming. NASDAQ is the top-second stock exchange in terms of market capitalisation traded, the first being NYSE. The stocks on NASDAQ are listed based on their respective market capitalisation. The popular NASDAQ indices are NASDAQ Composite and NASDAQ 100. Since the exchange is tech-heavy, so are the indices based on it. Therefore, it acts as a benchmark for the tech sector world over. The top stocks on NASDAQ by market cap are Apple, Microsoft, Alphabet, Tesla, Facebook, Amazon, NVIDIA, PayPal and ASML holdings, which comprise one-third of the market cap on the NASDAQ Composite Index. The number of stocks keeps varying to have a holistic approach to NASDAQ securities.

NASDAQ indices can be traded via CFDs and spread betting, while they can be invested via ETFs or trading shares. Indices have individual stocks of companies and exclude ETFs, although ADRs, REITs and LLPs are included. The investor has to be cautious about the margin requirements, which varies mainly between trading and investing, and the time frame involved. Investors who want to automate their portfolio and do not want to manage it actively can go for index ETFs as this gives them good profits in the long run, given the stocks of the best companies are listed on the index. Those who wish to keep their trades short and profit from the swings with adequate knowledge and indicators can go for CFDs, as these are highly speculative.

Why trade indices?

Although all traders have their favourite assets like the do when trading commodities, the S&P 500, Nasdaq, Dow Jones, DAX 30 or FTSE 100 would probably be in traders’ top list. Below are some of the reasons traders usually enjoy adding an index in their investment portfolio.

Diversification of portfolio

When trading indices you are basically investing in a broad range of companies though an asset, so if one or more companies fail, the index will still be “safe”. Also, you have the ability to build a diversified portfolio based on the major tech companies worldwide.

Fewer risks

Besides the fact that indices trading is a relatively safe form of trading compared to trading forex, there is always the risk of volatility due to political or economic events, like in any other tradable asset. Moreover, an index can hardly to bankrupt or affected by the competition. It is possible but not likely.

Less study

Trading stocks usually requires a more thorough research and financial understanding of a company. Indices trading simply requires a more balanced economic view in general. With indices it’s very simple. If traders believe that the market could grow in the future, they will buy an index CFD. If not, they will sell it. All in all, trading indices is a nice way to speculate on the top financial markets of the word and stay up to date with the top stock markets without having to get into analysing how individual companies perform.

DISCLAIMER: This information is not considered as investment advice or an investment recommendation, but is instead a marketing communication