Indices or Indexes are a measurement of the performance or value of selected stocks in an entire stock exchange or a section of the stock exchange. The value of a stock index is measured using a performance weighted average of the prices of the stocks that make up the index being measured.
The value of a stock index changes on a day to day basis, which is what is exploited to make stock indices a tradable asset.
Characteristics of Indices
Indices have characteristic features that set them apart from other assets.
“Trading on the core indices can only be performed during the trading hours of the stock exchange tracked by a particular index, or when a particular sector is open for trading”
a) Indices are leveraged financial products. They are typically traded with low leverages and high margin requirements on many platforms. These margin requirements are sometimes so high that the exchanges have to offer smaller versions of these contracts (the mini futures) to enable a lower capital entry requirement.
b) Trades on indices in the options market are timed. They have a maximum time limit of 3 months.
c) Indices may be traded bi-directionally. Traders may assume long positions on rising index prices or go short on falling prices
Table of indices as CFD instruments
Types of Indices
Stock indices can be said to be of three types:
a) Sector indices
b) Country and cross-border indices
c) Thematic indices
Sector indices are designed to measure the performance and valuation of stocks that are grouped into a particular segment or industry of the stock market. The reasoning behind the creation of sector indices is to help investors understand the performance of a particular segment of the market. Another goal is to be able to have a peer-group benchmark on which an individual stock can be measured. An example is the Next Biotechprice-based index which is made up of the 25 biotech companies which are listed on Euronext.
Flagship indices that evaluate the performance of national stock exchanges are termed country indices. The majority of the indices seen on trading platforms are national indices. Well-known examples are the FTSE100 (UK), Dow Jones Industrial Average (US), CAC40 (France) and DAX (Germany). Most of trades on indices are centred on country indices.
Thematic indices which group assets into specialized themes such as emerging markets or healthcare indices, are not very commonly used in trading.
How to Trade Indices
Most indices traded in the market are sector and country indices. They may be traded in several ways.
One of the most popular ways is to trade them as CFD instruments on a CFD online platform. This would involve performing analysis on the direction of the index for a particular period of time and attempting to profit from the direction by either going long or short.
Another way that indices are traded is by trading them as vanilla options. This involves adopting a Call or Put position on the index asset. Most professional traders use the options trades to hedge the trades they have placed on the traditional CFD market.
It must be stated here that trading on the core indices can only be performed during the trading hours of the stock exchange tracked by that particular index or when a particular sector is open for trading. In the options or futures markets, the futures contracts of the indices are open for trading all through the day, although the greatest movements are seen when the underlying markets are open.