What is an index?
An index in layman’s language is a measure or an indicator of something. In finance, a stock index helps investors calculate the market performance by comparing the current prices with past prices. The stock index represents a group stock from a country. For example, the FTSE 100 index is a representation of 500 companies that are on the London Stock Exchange.
The stock market is something that people talk about everywhere on television, magazines, and radios, not to forget the internet. A day will not go by without hearing index names such as SP 500, DAX-30, Don Jones Index, and many others.
How indices work
Since stock indices represent the value of a group of stock, when they fall or increase, they indicate the stock’s overall performance. For example, If the S&P 500 from the US goes up, the stock’s overall performance within the index goes up as well. The higher the price of stock indices, the higher the overall value of the indices. The overall value of the index decreases when the stock index decreases.
It is important to note that the individual stock prices may not be directly affected by the stock-index direction. Some stocks may be going down while others are falling.
How to calculate stock indices?
The weight average formula is the calculator of stock indices. It is used to determine the index value. To calculate the weight of the share, do the following math.
Share price X the number of shares/market capitalization of all shares. Market capitalization is the method used by indices weigh companies.
Pros of trading market indices
1. Better trends
When you compare stock indices with stock, they have better trends because their moves are dependent on the stock market price. It is easy for an investor to determine the stock indices’ direction because the stock market price moves in one direction. When the stock price increases, the indices increase as well, and vice versa. If you are an investor already, you may need to keep track of insiders and their trading. Check out insidertrades.com.
It is easy for an investor to get all-stock diversification to reduce the risk of losing their investments. Diversification allows investments to be allocated in various industries and financial instruments to maximize returns.
3. There is no manipulation in indices
Compared to other financial instruments such as Forex, it is difficult to manipulate indices. Indices are not a matter of purchasing. An investor can invest any amount of money on indexes. A person does not determine the change of price in an index but the price of shares. The price change is the weighted average of several companies, and if the cost is manipulated, it can cause significant changes.
4. Trading in indices is less risky
Investment in other companies can lead you to lose all your investments. Trading in indices has never and can never make you bankrupt. Risk-averse investors can consider this type of investment.
5. Every index has its own personality
Indices do not have the same characteristic. They differ from one to another by adapting to the day trading scalping and swing trading.
6. They have long-term trading options
The long-term option is for people who want to sell their industries at a profit.
You trade in a market you know. Trading in a market you know is important because it helps you again on your investment. It also enables an investor to spread risks and earn a greater reward.
Cons of trading market indices
- There are more gaps in indices when the market is closed compared to Forex. The stock price may fall drastically from one level of trading to another and cause loss to an investor.
- The brokerage fee on less traded indices is higher.
- Trading is only applicable during the local business hours and like Forex, where you can trade 24hrs.
- Some indices are not liquid.
How to trade in stock indices
If you’re planning to trade in stock indices, follow the following steps:
- Open a trading account – A trading account is opened through a Contract for Differences (CFD) broker. The broker act as an intermediary between you as an investor and the market.
- After opening an account, open a Meta Trader 5 trading platform. This is a free application used by traders to perform trading operations and does the trading analysis.
- In the application, look for the index you will be trading with, such as in NQ100, SP500, or DJI30.
- Open the chat and open a buy or sell trade.