Trading Stock Indices

Factors influencing index prices Indices are generally affected by macro events. For example:

― Political instability

― Macroeconomic factors such as inflation, interest rates or unemployment

― Factors affecting companies which have a large weighting in the index and those operating in the same sector

Why trade indices?

Index trading has many benefits that make it a popular choice for both speculation-based trading as well as hedging.

1. Diversification Trading an index means risk exposure is spread across a basket of stocks, instead of on one specific stock. This makes index trading attractive to speculators.

2. Volatility When trading a single company stock, a trader will be fully exposed to that stock’s volatility. However, an index’s volatility will tend to average out across the stocks making up the index.

3. Hedging Equity markets tend to be positively correlated with a country’s economic performance. For this reason, stock and index markets can be an effective hedge for markets that are inversely correlated with the economy (such as safe-haven currencies and commodities). Also, stock traders with exposure to multiple stocks in an index, could choose to offset the risk of a fall in shares prices by shorting the index.

How to trade stock indices?

Indices can be traded using an ETF (exchange traded fund), which can be traded like single stocks on an exchange. Derivative products such as spread betting or CFDs can also be used and mean the trader can transact without owning the underlying asset. Index futures are another derivative product that can be used to trade the index markets. When you trade a futures contract, you are agreeing to exchange a specific stock index at a specific date in the future at a price agreed now. A benefit of trading a futures contract is that these are available outside stock exchange trading hours with some even being traded around the clock. In addition, they are traded on margin and can be closed out to realise a profit or a loss before the contract’s expiry date. This means futures market can be more price-responsive by reacting to external events before the index market opens for trading on a given day. In this respect, index futures can often indicate where the index will open.

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