Index Trading: index investing for dummies
1. What is Index Trading?
Index Trading is unlike commodity trading where a trader invests in a commodity or Forex trading
where one invests in a currency.
An index is basically a figure that reflects the health of a market or an economy so when you invest in an index you are essentially investing in a fund that mirrors the
movement of the index.
What index trading enables you to do is to invest in a very large segment of a market, or even an entire market itself.
For example, in stock index trading, you have the option of
investing in the FTSE 100, NASDAQ, the Dow Jones, or the S&P 500, among other indices, all of which reflect different broad market properties. By investing for instance in the Dow, you would be investing in a significant portion of the industrial market.
2. Why Trade Indices instead of Shares?
Here are a few of the advantages of trading indices instead of individual shares:
Index Trading is unlike commodity trading where a trader invests in a commodity or Forex trading
where one invests in a currency.
An index is basically a figure that reflects the health of a market or an economy so when you invest in an index you are essentially investing in a fund that mirrors the
movement of the index.
What index trading enables you to do is to invest in a very large segment of a market, or even an entire market itself.
For example, in stock index trading, you have the option of
investing in the FTSE 100, NASDAQ, the Dow Jones, or the S&P 500, among other indices, all of which reflect different broad market properties. By investing for instance in the Dow, you would be investing in a significant portion of the industrial market.
2. Why Trade Indices instead of Shares?
Here are a few of the advantages of trading indices instead of individual shares:
- More available leverage than trading shares - The leverage possible with Index future contracts creates a profitable environment for even trades of a few percent index gain.
- Less technical analysis - investors are able to spend more time on analyzing one chart, then trying to screen through thousands of stocks for the right company
- High liquidity - The highly liquid market also creates tighter spreads which translates into less money spent per transaction.
- No need to screen stocks for fundamental data - A lot of time is saved from not having to analyze financial reports. The trader will spend most of his time looking at the big picture and overall market sentiment.
You can trade indices via a CFD (contract for difference), ETF, index future or options. They all have their strengths and weaknesses.
A CFD is not a standardized instrument listed on exchanges. It is essentially a betting instrument provided by a firm for you speculate in the particular market you are interested in. There are stock CFDs, commodity CFDs and other types of CFDs. The advantage of CFDs is the ability to trade in micro lot size.
We offers its clients access to either the Saxo Trader 2 Platform or IG's Platform. It allows our clients to trade CFD contract sizes from as low as £1 per point on the FTSE 100 index for example. This allows you to speculate without risking the kind of money that index futures would require.
The disadvantage with CFDs is that firms offering the CFDs have to make money off the spread of the price. Spread is the difference between the best bid and ask price at any moment.
In this Index CFDs are often simpler to comprehend as they trade at the spot price (with a small commission on top) and do not expire.
Index futures are traded on a Futures Exchange and have an expiry date and thus their pricing includes a forward premium of interest and a discounted dividend which can be confusing.
There is no special advantage to trade the ETFs (e.g. SPY). A standard lot is 100 shares. Going below the regular lot size your trade may have to be routed to odd-lot dealers as oppose to directly handled through the regular channels. If you have very small size trading account, trading ETFs is not as flexible as trading CFDs.
One common day trading strategy is Trend Trading. This strategy relies on the belief that a price will continue in a specific direction over a given period of time. For example, an index that is rising in price will continue to rise. Alternatively, an index that is falling in price will continue to fall. Traders are advised to exit the market when the price diverts from its current trend.
Investors utilise trend lines and resistance lines to predict when the price will divert from its current direction as discussed earlier.
Scalping is one of the most popular strategies, which involves selling almost immediately after a trade becomes profitable. Here the price target is obviously just after profitability is attained.
Fading involves shorting stocks after rapid moves upwards. This is based on the assumption that (1) they are overbought, (2) early buyers are ready to begin taking profits and (3) existing buyers may be scared out. Although risky, this strategy can be extremely rewarding. Here the price target is when buyers begin stepping in again.
This strategy involves profiting from a stock's daily volatility. This is done by attempting to buy at the low of the day (LOD) and sell at the high of the day (HOD).Here the price target is simply at the next sign of a reversal, using the same patterns as above.
This strategy usually involves trading on news releases or finding strong trending moves supported by high volume. One type of momentum trader will buy on news releases and ride a trend until it exhibits signs of reversal. The other type will fade the price surge. Here the price target is when volume begins to decrease and bearish candles start appearing.
News creates what experts call “Volatility” in the market. Along with volatility, comes a market opportunity. Traders must determine how the market in general will respond to news. Once this is determined, traders may earn a profit based upon the speculation. Investors must be able to make split second decisions with this strategy.
Post a Comment