Let’s discuss indices and how we trade them
Any newcomer trader can be confused with the question ‘what are indices?’. All stock markets have major indices which report the performance of key shares quoted on their exchange. Market Indices are a method to gather sentiments about the overall market which gives you a signal of whether you’re in a bull or bear market.
Trading indices rather than just stocks gives you exposure to all firms listed on indices since there are numerous companies listed on the major indices.
Indices definition and their role in the trading process
The technical indices definition can be summarized in simple words as “The exchanges shares separated into sub-sectors/industry wise.” This way anyone can have more than one way to trade a stock. This also means particular parts of the marketplace could be analyzed in terms of commercial or industry sector.
For instance, a firm “Shell” is quoted as an individual stock on the stock exchange and also a member of the oil and gas index.
Indices reflect how all oil and gas shares quoted on the stock exchange have performed where oil and gas index itself is a part of the overall marketplace.
This means when an investor is looking at his trading strategies and thinks how to buy the indices, he will have an overall view of the market along with how oil and gas are performing specifically. He may have a very strong view on the individual stock, say, Shell.
What are indices?
Indices are the plural form of an index and before discussing different types of stock market indices, let’s have a look at what an “Index” is. It is a statistical indicator which shows changes in the economy. In terms of financial markets, an index can be explained as a portfolio of securities representing a particular market of a segment of the market.
In simpler terms, let’s say “A” is a set collection of 50 stocks having a large volume and traded every day; it is an index covering 50 stocks or in other words, these 50 stocks are used as an index and determine the movement of the market.
A stock index is an indicator of the overall performance of the marketplace or a single sector. It acts as a benchmark for portfolios performance. These portfolios belonging either to individuals or mutual funds use this index to measure for appraisal of their performance.
Our recommendations are once you have selected one, spend some time researching the constituents with sectors that are in there, the type of market, the type of companies quoted there, the volatility of these firms, and news flows.
DAX, Dow-Jones, and FTSE are some of the magical words you observe every day on your television’s newsfeed. For investors, these are not mesmerizing anymore as any change in their value brings stress for them and brokers. These changes also impact policymakers to implement changes in their economies.
How to buy the indices
For anyone new to this domain, trading these indices and easily boosting the profits is a dream. Here, we will help you find out how to trade on the indices. First, think about why prefer indices over the individual stocks.
As explained previously in this article, you will get an overall outlook on the international market from Indices. By trading indices, you get to comprehend the firms quoted there, their conditions and the shares they represent. For instance, trading on the FTSE 100 index will give you an idea about the movements of the top-valued British firms.
Indices also assist you in focusing on a selection of shares which make up an index, so you are not confused due to the varied selection of stocks and firms.
Indices’ diversified nature is another bonus aspect as it diminishes the chances of unusual prices changes based on the unexpected news announcements.
As an investor, there are certain key factors which you should take into consideration before you buy indices.
1- The very first factor is to read and understand the parts which compose that index. For instance, take Equities. Does an index composed of equities belong to different market sectors or just one? Understanding this and finding the answer helps to focus on a specific sector and its updates or news releases that can possibly influence the value of that index.
2- The second factor is to carefully analyze the correlation between indices and currencies. A domestic index or indices are usually with a country’s currency and its conditions. For instance, when the demand for US dollars increases, the value of US indices also rises.
The main cause for this lies in foreign investment. Why? Investors need to purchase dollars first when they are investing in US stocks. This influences the American indices to increase in value.
3- Third, observe the presence of any possible link between the commodities market and the country’s domestic index. For instance, you can observe this correlation for Oil exporting and importing firms and their respective indices. A country importing oil will have a likely drop in its index on low crude prices. On the other hand, the index of an oil exporter country is likely to rise.
4- Lastly, keep a regular check on any changes in index listings. The shares that constitute any index can witness change due to mergers and acquisitions or market capitalization.
For instance, the company “X” is regarded as a valuable company that has the biggest capitalization like other big firms. Market capitalization for a firm can be explained by how the market assesses the total worth of its “issued” shares. The individual stock price of firms can impact an Index.
So, if there is a decline in market capitalization of company “X”, its shares can be replaced with another firm with a bigger market capitalization as “X” shares are now very small to be quoted on the index.