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Indices Trading Strategies

Trading on indices in its most regular format involves speculating on the movement of a weighted average of a portfolio of stocks. Having some form of strategy at hand may be beneficial when it comes to entering a trade. Here are some points to consider:

  • 01

    An Index’s Component Stocks

    Before trading on an index, make sure to examine its component stocks; whether the index is made up of stocks from a specific market sector, or is primarily filled with firms from a particular country, knowing the kinds of stocks an index lists will give you a better idea of the factors that can cause its movement.

    For example, FTSE 100 firms are those with a claim to the largest market capitalisation in the UK. Such companies represent around 80% of the wealth of the LSE – the London Stock Exchange, meaning that the FTSE 100 provides a fair representation of the current condition of the UK market in general. In addition, a tenth of the FTSE 100’s listed shares are within the mining and energy sectors. Because of this, the fluctuating prices of mining and energy commodities such as copper, iron and oil, could directly affect the values of these shares, and could therefore potentially cause movement of the index as a whole.

    The number of companies that an index is comprised of can range from 30 to 5000; for example, Germany’s DAX 30 and the Wiltshire 5000 index. When choosing which index to trade, it can be worth making the number of listings in an index a factor in your decision decision. Larger indices may require a bigger-picture knowledge of the economic condition of a country or market sector, which may suit some people, whilst others may find smaller indices more suitable to trade.

  • 02

    The Correlation Between Currencies and Indices

    The relative strength of a country’s currency and the value of its domestic index are usually closely associated together. For example, the value of American indices are – up to a point - seen to increase with the demand for USDs. This could be partly due to foreign investment; as a growing number of traders invest in US stocks, they must first purchase USDs to buy them, in turn causing US currencies to increase in value.

  • 03

    The Correlation Between Commodities and a Country’s Domestic Index

    There are a number of currencies which can be affected by the changing values of certain commodity prices. For example, if oil prices fall due to a weaker global demand, countries which primarily export oil would feel the negative effect, since they will not be able to sell their product for as much. By contrast, those countries which predominantly import oil would feel the benefits of being able to purchase this commodity at a cheaper price.

    Because of this, it may be worth paying attention to commodity movements which have the potential to influence the level of an index which you have taken a position on.

  • 04

    Monitoring Updates to Index Listings

    Index-listed stocks are updated semi-regularly (sometimes quarterly, sometimes yearly), to reflect the highest performing companies in the relevant sectors. The stocks listed on an index can change due to reasons including a company’s increased/decreased market capitalisation and mergers & acquisitions. Below we describe these two factors in a little more detail.

    I) Market Capitalisation

    A company’s performance is often gauged by indices through the means of calculating its market capitalisation, instead of sales or total asset figures. A firm’s market capitalisation is defined as the total market value of its issued shares.
    Market capitalisation = total issued shares x current market price of one share.

    II) Mergers

    When two businesses decide to fuse themselves into one firm, the stocks representing the previous two companies also combine. For example, when Dixons and Carphone Warehouse merged in 2014, the two company’s stocks combined into one, Dixons Carphone.

    To start trading indices, register for a trial account to start practicing, or sign up for a live account.

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