What are indices and how do you trade them?

What are indices?

Indices are a measurement of the price performance of a group of shares from an exchange. For example, the ASX 200 (known as the Australia 200 on our platform) tracks the 200 largest companies by market capitalisation on the Australian Securities Exchange. Trading indices enables you to get exposure to an entire economy or sector at once, while only having to open a single position.

You can take a position on the price of indices rising or falling without taking ownership of the underlying asset with CFDs. Indices are a highly liquid market to trade, and with more trading hours than most other markets, you can receive longer exposure to potential opportunities.

How are share market indices calculated?

Most share market indices are calculated according to the market capitalisation of their component companies. This method gives greater weighting to larger cap companies, which means their performance will affect an index’s value more than lower cap companies.

However, some popular indices – including the Dow Jones Industrial Average (DJIA) – are price-weighted. This method gives greater weighting to companies with higher share prices, meaning that changes in their values will have a greater effect on the current price of an index.

What are the most traded indices?

1. DJIA (Wall Street) – measures the value of the 30 largest blue-chip shares in the US
2. DAX (Germany 40) – tracks the performance of the 40 largest companies listed on the Frankfurt Stock Exchange
3. NASDAQ 100 (US Tech 100) – reports the market value of the 100 largest non-financial companies in the US
4. FTSE 100 – measures the performance of 100 blue-chip companies listed on the London Stock Exchange
5. S&P 500 (US 500) – tracks the value of 500 large-cap companies in the US

How to identify what moves an index’s price

An index’s price can be affected by a range of factors, including:

• Economic news – investor sentiment, central bank announcements, payroll reports or other economic events can affect underlying volatility, which can cause an index’s price to move
• Company financial results – individual company profits and losses will cause share prices to increase or decrease, which can affect an index’s price
• Company announcements – changes to company leadership or possible mergers will likely affect share prices, which can have either a positive or negative effect on an index’s price
• Changes to an index’s composition – weighted indices can see their prices shift when companies are added or removed, as traders adjust their positions to account for the new composition
• Commodity prices – various commodities will affect different indices’ prices. For example, 15% of the shares listed on the FTSE 100 are commodity shares, which means any fluctuations in the commodity market could affect the index’s price

Why trade indices?

By using indices as a trading vehicle, you can:

1. Get immediate exposure to an entire index
2. Go long or short
3. Trade with leverage
4. Hedge your existing positions

Get immediate exposure to an entire index

A primary advantage of trading indices using derivatives like CFDs is the sheer breadth of market exposure accessed in a single position.

Indices, as a representation of an entire market or industry, measure the overall performance of all shares included within the index. For example, let’s say a notable event occurs that affects the market as a whole rather than just a few specific companies. By taking a position on an index like the ASX 200 (known on our platform as the Australia 200), you trade on how the incident will impact a wide cross-section of the most important shares in an economy or sector.

When you trade an index in this way, you also take your position at the exact price of the market at the time you trade, minus any charges incurred. It’s important to note that CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage so you should take steps to manage your risk.

To gain a similar level of exposure through traditional investments, you’d have to incur the time and monetary costs of purchasing the individual shares making up the index, or buy an exchange traded fund (ETF), which would be priced according to the fund's net asset value.

Simply put, indices trading is an immediate and direct way to trade on the movements of the total market at its current price.

Go long or short on an entire index

When index trading with CFDs, you can go both long and short. Going long means you’re buying a market because you expect the price to rise. Going short means you’re selling a market because you expect the price to fall.

This means you can take a position to profit if an index's price decreases in value.

With CFD trading, your profit or loss is determined by the accuracy of your prediction and the overall size of the market movement.

Trade with leverage

CFDs are leveraged products. This means you only need to commit an initial deposit – known as margin – to open a position that gives you much larger market exposure.

When trading with leverage, you should remember that your profit or loss is calculated using the entire position size, not just the initial margin used to open it. This means that while leverage can magnify profits, it can also amplify losses.

Before trading, you should always consider whether you understand how leveraged instruments work and whether you can afford to take the high risk of losing your money.

Hedge your existing positions

An investor with a collection of different shares might short an index to protect themselves from losses in their portfolio. If the market enters a downturn and their shares start to lose value, the short position on the index will increase in value – offsetting the losses from the shares. However, if the shares increased in value, the short index position would offset a proportion of the profits made.

If you had a current short position on several individual shares which feature on an index, you could hedge against the risk of any price increases with a long position on that index. If the index rises, your index position will earn a profit, counteracting a proportion of the losses on your short share positions.

How to trade indices

1. Choose how to trade indices
2. Create an account and log in
3. Decide whether to trade cash indices, futures or options
4. Select the index you want to trade
5. Decide whether to go long or short
6. Set your stops and limits
7. Open and monitor your position

Choose how to trade indices

With us, you can use CFDs to trade indices. CFDs are financial derivatives, which means you can use them to take a position on indices that are rising in value, as well as falling.

CFDs

A ‘contract for difference’, or CFD, is an agreement to exchange the difference in price of an underlying asset, as measured from the time the contract is opened until the time it’s closed.

For example, you think the ASX 200 is in an upward trend and will rise from its level of 7100. You buy an ASX 200 CFD worth $10 per point, and your market forecast turns out to be correct – the index increases to 7200. The difference is 100 points, so your profit is $1000 – excluding other costs. If the market had moved against you, however, and you closed at a level of 7000, your loss would be $1000 – excluding other costs.

We offer undated cash CFDs for short-term positions, and CFD futures and options for longer-term views.¹

Decide whether to trade cash indices, futures or options

When you trade with us, there are three main ways to get exposure to an index’s price – via cash indices, index futures or index options. These markets give you access to the performance of an entire index from a single position.

Alternatively, you can also opt to trade or invest in an index-tracking ETF or shares of companies that are included in your chosen share index.

Cash indices

Cash indices are traded at the spot price of the index, which is the current price of the underlying market. Because they have tighter spreads than index futures, they’re favoured by day traders with a short-term outlook.

Many traders will close their cash indices positions at the end of the trading day and open new positions the following morning to avoid paying overnight funding charges.

Index futures

Trading index futures means you agree to trade the index at a specific price on a specific date. Index futures are popular among longer-term traders because the overnight funding charge is included in the spread – enabling you to hold positions for a long time without this additional cost. When trading CFDs, you won’t pay a commission on index futures

Index options

When you trade options with us, you’ll be using CFDs to take a position on an option’s premium – which will fluctuate as the probability of the option being profitable at expiry changes. Owing to their complexity, options trading is often only recommended for experienced traders.

Additionally, please bear in mind that there is substantial risk when selling options. Selling a call, for example, incurs potentially unlimited risk as market prices can keep rising – theoretically, without limit.

ETFs and shares

Aside from cash indices, futures and options, you can also trade index ETFs and individual shares with us. Again, you can open these positions with CFDs.

But, if you’d prefer to buy and hold or buy and sell actual shares instead of trading on price movements with derivatives, you can invest in index ETFs and constituent companies through our share trading platform using our custodial model. This means that as a registered broker we manage, hold and safeguard securities you choose to buy and sell on your behalf.

When investing in ETFs or shares with us, you become a beneficial owner via our custodial model instead of taking direct ownership of shares.

Select the index you want to trade

It’s important to choose an index that’s best suited to your trading style. This will depend on your individual appetite for risk, available capital and whether you prefer taking short-term or long-term positions.

For example, the Germany 40 (based on the DAX price) is usually a volatile index favoured by traders with high-risk appetites and who prefer short-term trading. On the other hand, the US 500 (based on the S&P 500 price) is largely known for its steady returns over time, making it a favourite with traders with lower appetites for risk and a long-term outlook.

We offer over 80 major and minor global indices markets for CFD trading. We also offer nine indices on our options – meaning that you’re more likely to find a market that fits your individual trading style.

Decide whether to go long or short

Going long means that you’re speculating on the value of an index increasing and going short means that you’re speculating on its value decreasing.

If the economic outlook for an economy or sector looks good based on the performance of the companies listed on an index, a long position could help you realise a profit if the index increased in value. To go long, you’d elect to ‘buy’ when opening your trade.

If the outlook is poor – possibly because large companies listed on a capitalisation-weighted index are underperforming – you might want to go short on the expectation that the index will fall in value. To go short, you’d elect to ‘sell’ when opening your trade.

Please note, however, that all trading incurs risk and that past results are never a guarantee of future results.

Set your stops and limits

Stops and limits are essential tools for managing your risk while trading indices. A stop order will close your position automatically if it goes to a less favourable level than the current market price, while a limit order will close your position automatically if it goes to a more favourable market price.

Normal stops are free of charge but there is no guaranteed protection against slippage – so your position could be closed out at a worse level if the market gaps. A guaranteed stop will always close out your position at exactly the price you’ve specified, but they do incur a fee if triggered.²