Indices are often mentioned in market news, but what exactly are they, and how can you trade them? Unlike individual stocks, an index tracks the performance of a wider group of assets, such as the S&P 500 or FTSE 100.

In this guide, you will learn how index trading works, what influences index movements, which major indices to know, and the potential advantages and risks of trading indices through exchange-traded funds (ETFs) or contracts for difference (CFDs).

What Is Index Trading?

An index tracks the performance of a specified basket of securities or other assets, based on a predefined methodology. Indices may focus on a market, country, region, sector, company size, investment style, or asset class. For example, equity, bond, and commodity indices. 

An index is a calculated benchmark and thus cannot normally be bought directly. Investors and traders can obtain exposure through products linked to it, such as index funds, ETFs, futures, options or CFDs. These instruments differ substantially in ownership, costs, leverage and risk. 

What Affects The Price of Indices?

Indices are priced based on the securities they represent, according to their weighting methodology. For example, some indices weight companies by market capitalisation, while others are price weighted or equally weighted. Consequently, not every constituent has the same effect. 

In a market-cap-weighted index, movements in the largest companies can have a substantial influence, while smaller constituents have less impact. Broad indices can reduce exposure to company-specific risk, but sector, country, and highly concentrated indices may offer much less diversification.

Index movements may be influenced by company earnings, economic growth expectations, interest rates, inflation, currencies, commodity prices, political developments, and changes in investor risk appetite. 

Indeed, some popular indices such as the S&P 500 are widely used as benchmarks of their respective markets, although they are not complete measures of an economy. 

As an index covers a basket of different assets, it is inherently more diversified than singular securities or equities, which renders it an effective way to increase portfolio diversification.

Some factors that can affect equity indices include:

• Economic downturns: During a recession or a period of weaker earnings expectations, equity indices may face downward pressure, causing their prices to fall. However, markets do not inevitably fall throughout a recession and may recover before economic data improve. 
• Interest rates: Interest rate hikes can increase borrowing costs, which can in turn, lower the present value investors assign to future corporate earnings. Their effect varies according to economic conditions and market expectations. 
• Inflation: High or unexpected inflation can raise business costs, reduce purchasing power, and prompt tighter monetary policy. Its effect typically differs across companies, sectors, and periods. 
• Geopolitical events: Market indices can be impacted by geopolitical events, such as elections, conflicts, trade disputes, and diplomatic developments. These events can change an investor’s or trader’s expectations about economic policy, trade, energy supplies, and risk. If the market gets buoyed by positive developments, market indices can be potentially uplifted, too. 

Top 5 Indices That are Popular Among Investors & Traders 

If you’re looking to invest and/or trade indices, here are five popular indices to check out:

1. S&P 500

The Standard & Poor’s 500 Index (S&P 500) is perhaps one of the most well-known market indices. It measures the performance of 500 leading companies that are listed on major US stock exchanges, and is widely used as a benchmark for the US large-cap equity market. Take note that the index doesn’t simply contain the world’s 500 largest companies. Instead, companies must satisfy eligibility requirements relating to factors such as: 

• Market capitalisation 
• Liquidity 
• Public float 
• Financial viability

A decline of at least 20% from a recent market high is commonly described as a bear market. Conversely, a rise of at least 20% from a market low is often described as a bull market, although definitions and measurement periods can vary. 

2. Nasdaq-100

Another popular market index is the Nasdaq-100, which tracks 100 of the largest domestic and international non-financial companies listed on the Nasdaq stock exchange, based on market capitalisation. It has a substantial technology weighting and most of this index’s constituents are tech companies, so the Nasdaq is often used as a technology-heavy market benchmark. However, it also includes companies from other industries and does not represent the entire technology sector. 

3. FTSE 100

If you’re looking for UK indices instead, the FTSE 100 comprises 100 of highly capitalised, eligible UK companies listed on the London Stock Exchange (LSE). Also informally known as the ‘Footsie’, the FTSE 100 is widely used as a benchmark for the UK large-cap equity market”. However, as many of its constituents conduct extensive business overseas, its performance does not necessarily reflect conditions in the domestic UK economy alone. 

4. Nikkei 225

For exposure to Asian equities, the Nikkei 225 is a popular choice as a benchmark for the Japanese equity market. It’s a price-weighted index consisting of 225 selected Japanese companies listed on the Tokyo Stock Exchange’s Prime Market. Constituents are selected with reference to liquidity and sector balance, rather than company size alone. 

5. Dow Jones Industrial Average

The Dow Jones Industrial Average, also known as the DJIA or “the Dow”, is among the oldest and widely followed stock indices in the world. Launched in 1986, it is a price-weighted measure of 30 prominent US blue-chip companies. The Dow is an influential benchmark of the US equity market, although its relatively small number of constituents makes it narrower than the S&P 500. 

Trading Indices via CFDs

Since indices only track—but do not hold—any tradable securities, they cannot be directly purchased. Instead, investors and traders can obtain index exposure through instruments such as: 

• Exchange-traded funds (ETFs) 
• Contracts for difference (CFDs) 
• Index funds 
• Futures 
• Options 

For index ETFs, this simply means purchasing shares of a fund that seeks to track an underlying index. One such example is the SPDR S&P 500 ETF Trust (SPY), which is designed to provide investment results that broadly correspond, before expenses, to the price and yield performance of the S&P 500. The return of your holdings may differ slightly from that of the index because of fees, tracking error, and market-price fluctuations. 

Another way to trade indices is with index CFDs, which are derivative contracts that allow a trader to speculate on the price movements of an underlying market index, without owning the index or its constituent securities. CFDs are an advanced trading strategy that takes the form of an agreement between an investor and a trading brokerage. Both parties agree to exchange the difference in the value of an index between the time the contract opens and closes, subject to the provider’s terms.

Hence, if you expect the price of a referenced market to go up, you can open a long position. Alternatively, you can open a short position if you expect the price to fall. 

As CFDs are leveraged products traded on margin, this means a trader deposits only part of the position’s total value. Leverage magnifies both potential gains and potential losses, while spreads, commissions, and financing charges can reduce returns. 

Potential Benefits of Trading Index CFDs

Trading index CFDs can confer several potential benefits, such as:

• Lower initial margin requirement: CFDs can be traded on margin, which means investors can open a larger position with a smaller capital upfront. This allows CFDs to be traded even by those with relatively little starting capital. While this increases capital efficiency, it also increases risk. 
• Trade in any direction: As explained above, trading index CFDs allow traders to go long and short without owning the underlying securities. That said, a greater range of possible positions does not necessarily increase the likelihood of making a profit. 

Potential Risks of Trading Index CFDs

Index trading using CFDs is, of course, not without its downsides. These include:

• Leveraged losses: Relatively small market movements can produce substantial losses compared with the initial margin. A trader may lose all the margin committed and other funds held in the CFD account. 
• Margin close-out: Arm yourself with discipline and sound knowledge. Failing to grasp margin management can quickly lead to significant losses. If account equity falls below the required level, positions may be closed automatically, potentially during unfavourable market conditions. 
• Complexity: Achieving success in trading indices using CFDs requires an understanding of leverage, margin, financing costs, and rapid price movements. 
• Trading costs: Spreads, commissions, and overnight financing charges (swap fees) can accumulate, particularly when positions are held for extended periods. 

Tips For Index Trading 

Indices trading can be a rewarding yet complex endeavor. Whether you are a beginner or looking to refine your approach, having a structured plan and a disciplined mindset is crucial. Below are some key tips to help you navigate market volatility, manage risk effectively, and make informed trading decisions.

Follow Relevant Market Developments  

Index levels can be affected by economic data, company earnings, monetary policy and political or geopolitical events. Monitoring economic calendars and reliable news sources can help traders identify scheduled risks and understand potential sources of volatility. 

However, news events cannot reliably predict market direction, and expected developments may already be reflected in prices. 

Understand Different Forms of Analysis

Being able to interpret a price chart is important when trading indices. Besides price action, traders may also consider chart patterns, indicators, and other tools when planning entries, exits, and risk limits. Take note that these tools don’t guarantee accurate forecasts or profitable trades and should be combined with appropriate risk management. 

Besides technical analysis, some traders also consider fundamental information and broader macroeconomic influences. 

Select Appropriate Indices and Trading Instruments 

As you’ve learnt by now, indices differ in their constituents, weighting methods, geographical exposure, sector concentration, and volatility. Before trading one, consider its composition, largest constituents, liquidity, trading hours, and currency exposure. 

For instance, if you are highly keen on tech companies and already following important developments and new trends in that sector, you may be interested in trading a tech-focused index, like the Nasdaq-100, with a live trading account. 

Explore Indices Trading Today 

Trading and/or investing in indices can be one way to gain exposure to different types of asset classes and baskets of securities, without having to purchase individual stocks or commodities. Some investors also diversified their portfolio with indices. However, diversification would depend on the index’s composition and weighting, and does not prevent market losses. 

Experienced traders who understand leverage and margin may also use CFDs to take long or short positions on an index. That said, CFDs are complex, high-risk instruments, and the ability to trade in either direction does not ensure returns under any market condition. 

FAQs On Index Trading

RISK WARNING: CFDs are complex financial instruments and carry a high risk of losing money rapidly due to leverage. You should ensure you fully understand the risks involved and carefully consider whether you can afford to take the high risk of losing your money before trading.

Disclaimer: The information is provided for educational purposes only and doesn’t take into account your personal objectives, financial circumstances, or needs. It does not constitute investment advice. We encourage you to seek independent advice if necessary. The information has not been prepared in accordance with legal requirements designed to promote the independence of investment research. No representation or warranty is given as to the accuracy or completeness of any information contained within. This material may contain historical or past performance figures and should not be relied on. Furthermore, estimates, forward-looking statements, and forecasts cannot be guaranteed. The information on this site and the products and services offered are not intended for distribution to any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.