Trading Indices – Introduction to index trading

What are Indices relating to trading?

When you see the term indices in relation to trading, this is referring to market indexes. There are many indexes to choose from around the globe but more often than not, a large amount of trading centres around some core stock indexes. You may have heard banded around in conversation amongst investor or trader friends, names such as Footsie (FTSE), Dow and NASDAQ or if you are in Australia, the ASX. These are types of indexes, or indices.

Stock Indexes are a historical part of stock exchanges. It dates back to the late 1800s where the first Dow Jones Index (DJI) was created. Back in those days, the index was used to gauge the performance of the top 12 companies in North America at the time. The index was seen as a useful tool to also measure the performance of the economy as a whole. Trading indices was not a thing until the 1970s, when trading financial derivatives were first invented, and traded.   

Indices are shares that have been grouped together from one country or sector, and are usually the largest and most successful public companies. The stock index measures the value of the companies’ contained within. The total points of the index, is the total value of each stock within, combined.

Indices Price Movement

There are many factors that could see an index move in value. First, the individually contained listed companies’ performance against current and previous performance, will cause individual stock fluctuations, which in turn will cause the index to rise and fall. The difference between the days’ performance is measured either in points, or as a percentage. It is important to note that when trading indices, this is an average of all the companies stock performances within the group, so whilst some stocks may rise, others may be falling.

Price movements and volatility within the indices can also be impacted to political and or socio-economic events that can have a direct impact on how well companies are performing, and therefore how their stock price is trading.      

Indices vs stocks

Indices are rather different from stocks, certainly in the way that their performance is based on a group of companies, and not individuals. If we take the FTSE100 as an example; the companies are ranked by size and performance from 1 to 100, and it will always contain the top 100 companies that are currently listed on the London Stock Exchange.  In saying this, if the 100th company on the list is not doing so well, and slips its place to 101, the company that used to hold the 101st spot on the exchange will move up to take its place. 

This revaluing of companies and changing of those included in your trade, has the potential to lower your risk. With a company possibly dropping out of an index, to be replaced by another more recently successful business, you are in effect not only trading on the value of the companies contained within the index, but also the potential companies developing in a particular stock market and geographical economy.

Using the ASX as an example, which is most commonly trading in the number of 200 (ASX200), you are trading on the performance not just then of these 200 companies contained, but the overall economic outlook of Australia. If one company or sector is not doing so well at a given period, another may be profiting at their expense and bring up the average company performance.

So as you can see, indices trading is a lot more of a holistic view of a wider picture, rather than an evaluation of an individual. You are you are not putting all your eggs into one basket, but rather spreading your risk over many companies. For those who do not know how to evaluate PE ratios, and balance sheets, or those who have no interest in knowing the minute details of a company they wish to trade in, indices in this way can viewed as a safer, and simpler introduction to trading stocks.     

Major stock Indices worth trading

As touched on above, the indices you are trading in, has the potential to cover a range of geographies, or more localised. This will depend vastly on the number and the breakdown of the companies contained within. An index with 20 companies, made of the largest listed businesses in that Country, will usually be the big multinationals, or conglomerates. Massive in size and with a reach across multiple continents.

An index that contains a much wider base of companies on the other hand will usually have a lot more lower valued enterprises, and you can assume SMEs that are a lot more locally dependent. These variants then, such as the FTSE 350, are a lot more reliant on the performance of the UK economy than the larger multinationals found in the 100.

Take a look below at some of the key indices trading most globally, the variants usually traded, and the total number of companies that are trading on the index highlighted.

Name of Index	Abbreviation	Country  Listed	No. of Companies in Index
Financial Times Stock Exchange	FTSE (FTSE100, FTSE250 and FTSE350 most traded)	UK	641
The Dow Jones Industrial Average	DOW or DJIA	US	30
National Association of Securities Dealers Automated Quotations	NASDAQ (NASDAQ 100)	US	3300
Standard and Poors	S&P 500	US	500
Deutscher Aktienindex	DAX	Germany	30
Cotation Assistée en Continu	CAC	France	40
Hang Seng Index	HSI	Hong Kong	50
Australian Stock Exchange	ASX (S&P/ASX 20, 50, 100, 200 and 300)	Australia	2185
Shanghai Stock Exchange Composite Index	SSE	China	50
Nikkei	NI (NI 225)	Japan	225

How to start trading indices?

Firstly you have to choose an index that you would like to trade. This could align to where you are based geographically, to enable you to keep a close eye on the opening and closing of these markets, Although, this may not be the most suitable solution for some, it certainly is a starting point.  An index born from your hometown may give you an advantage as you may have a good understanding of how the economy there is performing.

Indices can also be based on different sectors, for example, the Nasdaq index is largely made up of US listed tech companies, such as Facebook, and Apple. Tech companies are growing and performing remarkably well at the moment of writing. The new Hang Seng Tech Index which has been recently released on the Hong Kong Stock Exchange, filters out tech and financial companies in Asia and can be a starting point for you if this sector of companies are of interest, but you feel the US market is priced a little high. 

Keep an eye on the basics

After choosing the index you would like to trade, it would be advisable to familiarise yourself with the companies within the index. It is not expected that you know all the ins and outs of all the companies listed, but it would greatly increase your chances of success with a base understanding of the companies and their business sector so you can keep an eye on developing news and reports that may have a material impact.    

When trading indices as a newcomer, it would be advisable to be on top of topical news that could affect the indices you are trading. You may hear of new legislation, any general top level announcements on that particular country’s economic performance, or unemployment rates. All of the above can have a direct impact on the performance of your index.

It could be said then, that is also important to look at each of the indices’ home economies as a whole, and to gain a wider perspective of their strong points, and weak points.  Trading indices is more about viewing the big picture macro economics rather than zoning into an individual company’s performance, so you can trade with a lot more general information than specific.

Which indices are most popular for trading?

As mentioned in the above table, there are numerous different indices around the world that could be of interest to you, but listed below are some quick general overviews on some of the most popular choices.

FTSE100.  The FTSE100 is a UK based index, with the top 100 UK companies listed on the London Stock Exchange. The companies listed are usually international corporations which trade with the rest of the world. 

The FTSE100 gives an overview of how these UK companies are connected internationally, and how the UK economy has fared due to recent events that may have had an effect on the UK economy. 

Local triggers such as unemployment rates, currency exchange fluctuations, Brexit and also global triggers such as the current CoronaVirus pandemic.  

FTSE350 and FTSE500. The little siblings of the FTSE100 may also peak your interest as the companies listed are lower in value and may not be multinational companies like the ones in the FTSE100. 

These include more of the smaller local companies. You may want to look at these closely if you are following the UK economic situation.  Owing to the fact that these include more companies than the senior FTSE index, you would be diversifying across a broader spectrum of sectors.  

NASDAQ index contains predominantly tech, and some finance companies.  As you may be well aware, the tech companies have been performing very well recently during Covid 19 pandemic, with many people turning to apps and software like Zoom to overcome distance working and distance learning solutions. 

If you are looking to trade tech stocks but without choosing a specific company, then the NASDAQ index represents a good choice.    

ASX 200 is made up of the 200 largest Australian listed companies.  These are multinational companies spread across a range of industries. 

The ASX 200 represents 80% of the value of all shares traded on the Australian stock exchange. It is broken up into 11 different sectors, with the 3 largest being financials (approx 25%), materials (approx 12%) and healthcare (approx 12%). Of those sectors, materials is also represented as an ETF (Exchange Traded Fund).

Gold and precious metal mining is also of focus in Australia, and historically people tend to secure their money in gold in uncertain times.

NIKKEI 225. Trading the major Japanese index is a good way to spread interest into one of Asia’s biggest markets.

Being the top 225 companies in Japan means that these enterprises are some of the bigger global multinationals, aswell as those with trading relationships across the majority of Asia as a whole.

Always demo before trading for real, indices are no different

With many of our articles on this site, to start any sort of  trading, we would recommend starting with demo trading until you feel comfortable with the platform and indicators you are looking at. Almost all online trading platforms offer the chance to practice trading, this will help you practice and understand how to trade indices before using your own personal funds. If you are looking for the best broker to demo trade with, take a look here.