Stocks give an indication of the financial climate for individual companies. Indices, on their part, offer another perspective allowing traders to step back and look at the bigger picture of what’s going on in the financial markets. However, the nature of an index means that traders need to take multiple stocks into account rather than a single company and most likely there will be larger number of aspects which are worth considering.
Indices: The Trading Process
In terms of trading, indices are similar to many other Spread Bet and CFD products. Indices are comprised of individual stocks based on which traders can take positions depending on whether they think that the value of an index will go up or down. Again, as with individual stocks the aim is to either ‘sell’ at a higher price than the one ‘bought’ at or alternatively to ‘buy back’ at a lower price than the one originally ‘sold’. All the stocks listed on the index will be included in the ongoing calculations to determine the current level of the index. Indexes rise or fall in value depending on the current strength or weakness of its component stocks.
The volatility of an index can be quite high due to constantly moving share prices as indices are made up of a number of different stocks. It is rare for indices to move by more than a couple of percentage points on a daily basis for the same reason as it’s unusual for the all stocks on an index to experience sharp movements in the same direction at the same time. There are occasions, however, when this does happen. Examples include the stock market crashes in the 20th and 21st centuries.
Indices Trading: An Example
In the following scenario, trader x decides to take a position on the FTSE100. Let’s say that the FTSE is currently trading at a level of 6949:6950 so that currently the spread is of one point. The trader decides to ‘buy’ £10 worth of the FTSE at the 6950 level. Since the ‘sell’ level is 6949, the trader starts off £10 down, because if the trader were to close this position immediately that’s the loss they would suffer.
Let’s see the development of the trade if the index subsequently moves up to a level of 6955:6956. If the trader were to sell his £10 worth of FTSE at this point, the profit on the trade would be £50. The first point of movement in the trader’s favour would turn their -£10 position into a £0 position (where they would be making neither a profit nor a loss and would break even if they exited at this point). The following five points of movement would be pure profit.
However, let’s consider a scenario where instead of the FTSE’s value rising, it falls to a level of 6945:6946. In this case, the trader would lose £50 if they sell at this point, because the price at which that £10 worth of FTSE is being sold is five points lower than the price at which it was purchased at.