Indices are powerful tools for portfolio diversification, and one of several financial markets ready for you to trade with Tradu. Read our indices trading guide to learn why and how they're compiled, how to trade them, and lots more.
- Indices meaning: What is an index?
- Can you trade an index?
- What are some of the most traded indices?
- What drives index prices?
- Pros of index trading
- Cons of index trading
- How do you trade indices?
- What is an index trading strategy?
- How to start trading indices
- Indices FAQs
Indices meaning: What is an index?
So, what are indices? Indices is the plural of index, which is a financial asset created to measure the price performance of groups of assets such as stocks or commodities. Calculated in different ways, indices combine the value of their selected assets into single aggregate values.
Indices are typically designed to represent certain economies, sectors or types of assets. As such, an index's performance is often seen to reflect the health of what it tracks, such as a domestic economy or the tech sector.
A single index can contain tens or even hundreds of assets – and here lies their key appeal for traders. Rather than buying and selling lots of individual assets, you can gain exposure to entire economies, sectors and more through a single position. This makes indices a popular tool for portfolio diversification.
How are indices compiled?
Indices are compiled by committees that set the criteria assets must meet to gain index status. For example, the popular FTSE 100 index is designed and managed by FTSE Russell.
Once an index is launched to market, this committee will meet regularly – usually quarterly or annually – to review its criteria and constituents. They may add or remove stocks based on their comparative performance against the index criteria. Many indices use performance buffers to limit volatility, however.
How are indices calculated?
Once a simple average, the value of indices can now be calculated in three key ways based on the stocks they comprise and their overall purpose:
- Price-weighted: Index constituents are weighted based on share price rather than size, giving greater influence to those with higher prices. The Dow Jones Industrial Average index and Nikkei 225 are prominent examples in this category.
- Market-capitalisation-weighted: Index constituents are weighted by value. Market capitalisation is worked out by multiplying the stock price by the number of publicly available shares, with larger market cap companies gaining greater index influence. The FTSE 100 and the DAX 40 are two popular indices of this type.
- Unweighted: As the name suggests, unweighted indices grant each holding equal weighting, limiting the influence of single assets over others. There's an unweighted version of the S&P 500, for example.
Read more in our guide to how indices are calculated. You can also read our trading glossary for an explainer of all the key terms.
Can you trade an index?
Now you know what an index is, it's time to get to grips with trading them.
This involves buying and selling specific indices, much like stocks, based on how you predict them to perform. But rather than owning the underlying assets of an index, you speculate on its price movements. You can do this through financial products such as contracts for difference (CFDs).
This allows you to open a profitable position in both directions depending on how accurate your prediction is. For example, you would:
- Buy an index market if you think its value will rise, known as going long.
- Sell an index market if you think its value will fall, known as going short.
There are lots of different indices available to trade, often with various factors affecting their value. Tracking these factors is what can help you make trade decisions like those above.
What types of indices are there?
Indices are created in different ways to suit different traders and trading needs, usually based on diversification. For example, key types of stock index include:
- Country-based: Designed to track the stock markets of specific countries, therefore reflecting their economies. Examples include the DAX 40, which is seen as the leading benchmark for the German economy.
- Exchange-based: Tracking the stocks of specific exchanges. One stock exchange can have several indices with different criteria – such as large or small cap – and numbers of constituents. The NASDAQ 100 index focuses on the top 100 non-financial stocks on the NASDAQ exchange, for example.
- Regional: Designed to give you exposure to broader geographic regions, typically continents or groups of related countries. For instance, the EURO STOXX 50 index tracks 50 of the largest companies in Eurozone countries.
- Sector-based: Set up to track particular sectors, such as tech, finance or healthcare, within a country or region. The NASDAQ 100 index is once again a relevant example as the bulk of its constituents are tech-focused.
That's not all. While stock indices are among the most common and popular, you can also trade commodity, bond, and currency indices.
What are some of the most traded indices?
All the world's major financial markets have at least one index designed to represent them. These examples are consistently among the most traded and often feature in financial news headlines:
- The S&P 500: Created in 1957 and tracking 500 large-cap companies listed on the various US stock exchanges. Notable holdings include Apple, Amazon, and Johnson & Johnson.
- The Dow Jones Industrial Average: Made up of 30 large blue-chip companies in the US. Launched back in 1885, today tracking giants such as Microsoft[TM1] , Goldman Sachs and McDonald's.
- The NASDAQ 100: Comprising the 100 "largest and most innovative non-financial companies" listed on the NASDAQ Stock Exchange. Created in 1985 with key components including Microsoft, Alphabet (Google) and Meta.
- The FTSE 100: Collecting 100 large-cap companies listed on the London Stock Exchange, with major names including AstraZeneca, Shell and Unilever. Launched in 1983.
- The DAX: Tracking the 40 largest companies on the Frankfurt Stock Exchange since 1988. Leading companies include Siemens, Airbus and Mercedes-Benz.
- The Nikkei 225: Japan's leading stock market index, tracking 225 companies on the Tokyo Stock Exchange and created in 1950. Well-known constituents include Toyota, Sony and Panasonic.
- The ASX 200: Compiled of 200 large companies, acting as the premier investment benchmark for Australia since 2000. Includes the likes of BHP, Qantas Airways and the Commonwealth Bank of Australia.
What drives the prices of indices?
Price movements can be driven by a broad range of factors depending on an index's unique makeup and characteristics. Key influences to potentially monitor as a trader include:
- Asset performance: The performance of individual holdings – particularly those with larger weightings – has a strong bearing on an index's overall price. It can pay to monitor releases such as company financial results, as well as announcements regarding new leadership or other major changes.
- Economic news: Various economic trends, data releases and announcements can impact an index depending on its design. National GDP and employment data will affect a country-specific index, for example. Central bank policies such as interest rate hikes can have a direct bearing too.
- World events: Similarly, many indices are impacted by international news and events. Natural disasters, political tensions and global financial crisis can all hurt index performance.
- Index composition: As indices get rebalanced regularly – many as often as quarterly – their composition may alter as assets gain or lose index status or have their weighting adjusted. Fast risers and fallers have the power to shift index value.
- Currency movements: Fluctuating exchange rates can impact both stock market and currency indices. The former is true if an index holds companies that generate lots of revenue abroad – one example being the FTSE 100.
- Commodity prices: Similarly, commodity value affects both commodity-specific indices and stock market indices tracking major companies involved in relevant industries.
- Investor sentiment: All the factors above can ultimately shift investor sentiment. And if they begin buying or selling off assets in increasing numbers, prices will fluctuate accordingly.
Pros of index trading
Indices are popular with traders for lots of reasons:
- Diversification: Indices give you quick exposure to entire regions, economies and sectors, broadening your investment horizons. You'll have better protection against individual asset volatility too. Read our guide to portfolio diversification.
- Efficiency: It's entirely possible to invest in an index's holdings individually. But opening a single index position will save you lots of time and effort, as well as reduce separate trade fees.
- News coverage: The most popular indices track world-leading markets, with regular news stories and analysis making them easier to track and trade.
- Trading indices through derivatives like CFDs allows you to profit from price movements in both directions, depending on how you predict the market to perform.
- Trade with leverage: Leverage is a powerful tool, allowing you to take larger positions from smaller initial deposits and potentially multiply your profits.
Cons of index trading
No financial market comes without serious risks attached. Here are a few to watch out for with indices:
- Volatility: While indices can provide more stability than individual assets, they're still susceptible to sharp price movements that threaten significant losses if unexpected. Volatility varies by index, so assess them on a case-by-case basis with your level of risk tolerance in mind. Our trading analysis resources can help you stay one step ahead.
- Index composition: Index constituents are decided by committees without any input from investors. As such, you won't get control over the individual companies or assets you gain exposure to. Share trading may suit you better if this is a problem for you.
- Limited returns: Protection from the volatile performance of individual holdings can be a positive. But you'll also see smaller returns from high-growth assets as a result, compared to investing in them directly.
- The risks of leverage: Remember that as well as magnifying profits, leverage can work against you in the same way. Even small price movements can lead to significant losses if unexpected. Read more about how leverage works.
How do you trade indices?
You can trade indices through contracts for difference (CFDs). These are financial derivatives, which means you can speculate on an index rising or falling in value. They're also leveraged products, allowing you to take larger market positions from smaller deposits.
What are index CFDs?
An index CFD is an agreement to exchange the difference in the price of the underlying asset between opening and closing the contract. The contract is between you as a trader and us as a broker and doesn't require you to own the underlying asset.
Learn more in our CFD trading guide.
What is an index trading strategy?
As with other assets, having a clear strategy will help you trade indices consistently and boost your chances of success. Popular approaches include:
- Trend trading: Focusing on an index's trend to identify extended patterns and trade in the same direction as them.
- Support and resistance trading: Identifying an index's support and resistance levels, which is where pricing struggles to fall below or rise above respectively. You'd then make trades within this range.
- Breakout trading: Spotting indices that 'break out' of established support or resistance levels.
Read up on these approaches and other options in our guide to index trading strategies.
Using fundamental and technical analysis
A key part of any trading strategy is the analysis you use to execute it. Trading analysis is commonly broken down into:
- Fundamental: Using economic developments and other news to judge the overall health of an economy, sector or asset and any index that tracks it.
- Technical: Using various indicators – primarily charts – to analyse index price movements and find patterns.
In most cases, using a combination of the two methods is the best way to inform your trade decisions. Read our guides to learn how to focus your research.
How to get started with indices
- Open a trading account. You can sign up for a Tradu account in minutes.
- Build your knowledge. Our market, trading and platform guides are great places to start.
- Develop your strategy. Choose which indices suit your goals and decide how you'll analyse and trade them.
- Open your first position. Our platform makes executing trades intuitive, fast and reliable.
- Keep building your skills and diversifying. Research other indices as well as alternative asset classes such as forex, stocks, commodities and crypto, all from one account.
Indices FAQs
How does index trading compare to stock trading?
There are some key differences between index and stock trading:
- Indices can provide exposure to lots of stocks through a single position, rather than buying and selling individual stocks.
- Indices are typically less volatile than stocks. This can both limit damage if a single stock performs badly and limit the gains offered by high growth.
- Tracking and trading indices demands less time and resources than researching individual stocks. That said, it can be trickier to spot trends in individual stocks than in large, varied indices.
- Indices don't offer control over the individual assets you invest in. If certain stocks aren't included, you'd need to invest in them directly to gain exposure.
The right market for you will depend on your trading style and preferences, such as risk tolerance.
How can you manage risk when trading indices?
It's impossible to eliminate risk when trading indices – but you can reduce it. Here are some steps worth taking:
- Determine your optimal position size: Judge what you're willing to deposit and potentially lose on any single trade, based on your available capital. Make sure to account for leverage and always use it sensibly.
- Use stops and limits: Stop and limit orders are helpful risk management tools. Use them to close orders automatically at less or more favourable levels than the current market price.
- Monitor price drivers closely: Certain drivers are easier to follow than others. You can make a note of upcoming economic releases, for example, to make sure you're ready for any price movements they might cause.
Read more in our guide to trading risk management.
What are the major index trading hours?
Unlike global forex markets, trading hours vary by index. Many leading stock market indices mirror the trading hours of their underlying stock exchanges, for example.
Check the trading hours for any index you're considering trading to understand when opportunities may arise. The best times to trade an index will depend on:
- The assets it holds
- Where it's based
- Trading hours of its underlying stock exchange if it's a stock index
- Key market drivers such as company announcements and economic data releases
Now you know what index trading is, deepen your knowledge or try our other market guides.
Stocks Trading
Forex Trading
Commodities Trading
