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So, you’ve found some pocket change lying behind the sofa and want to buy some stocks. You realise there are thousands of stocks to choose from. Should you pick your favourite clothing retailer or car manufacturer? Maybe you just want to ride the wave of all the stocks that are moving. Well, my friend, now you can. Welcome to the world of trading indices folks.
Stock market indices are one of the most quoted markets in the world. Granted, you won’t see them streaming across your screen on Netflix. But, if you tune into Bloomberg, or any other financial media outlet or newspaper, you’ll see that they are hot stuff.
If you’ve ever heard someone mention the price of the FTSE 100, Dow Jones 30, the S&P 500 or Dax 30 then they are quoting a stock market index. Essentially, a stock index just measures the price movement of a group of stocks from a particular stock market exchange, like the S&P for example. This means when trading indices like the FTSE 100, you are actually trading the price movement of the 100 largest stocks listed on the London Stock Exchange. Awesome right?
Now, you’re probably wondering what’s the freaking point of trading indices when you can just trade individual stocks. It’s a good question and one that deserves an answer….
This question is like asking why eat a burger and not the fries? You could eat both individually and be very satisfied. But, eaten together and that’s where the magic happens. Trading indices and stocks go hand in hand for some very simple reasons which we explore below.
Imagine a scenario where you’ve bought a collection of different stocks. They’ve moved in your favour quite nicely but you start to see the possibility of the overall market falling. You don’t want to cash out on your stock positions because you’re getting some healthy dividend income from them. (If you don’t know what dividends are, you can learn more here: WTF Are Dividends). But you also think this dip in the market will be temporary. What do you do?
Well, as you already know, a stock market index is based on the price of a collection of stocks put together. So, a trading pro would consider trading indices to ‘hedge’ their bets. That’s because you can short sell indices which means you can profit from a falling market. This way you can keep your individual stock positions and any losses on them will be cancelled out by the profit on your index trades (if everything goes in your direction of course). Now you know that’s awesome right?!
There’s also another reason why you may consider trading indices rather than individual stocks…
That’s right, with indices you can sample all the delights of the world from this very screen. Whilst you may not know a lot about US companies, you might think they’re going to be the next big thing. But by the time you’ve done your research, that next big thing will look as obsolete as a video tape. Instead, you can trade the US stock market indexes like the S&P 500 or Dow Jones 30. Or, you can sample some of the European flavours and get involved in the Spanish, Dutch or German indexes. The world is your oyster!
But before you get ahead of yourself let’s first figure out how to read these indexes.
Think of an index like a market in its own self. After all, they are quoted like anything else either going up or down ‘x’ amount of points. However, it is important to know that when trading indices the actual index itself is calculated in one of two ways:
1. Capitalisation-weighted makes up the majority of stock market indices. It means that a company with a high market capitalisation will have a greater impact on the price of the index. Basically, the bigger the company the more impact it has.
2. Price-weighted indices include the Dow Jones and Japan’s Nikkei. It means that the company with the highest share price will affect the price of the index more. A company with a share price of $500 with have ten times more influence on the price of the index than a $50 company. Sucks to be the little guy.
Ok, so how the heck do you start trading indices? Let’s find out…
Historically, it was quite difficult to trade stock indices. But, thanks to the rise of technology it’s never been simpler. Whilst indices don’t represent physical products like shares in a company, a currency or a commodity you can still trade them. That’s because some of the biggest stock exchanges in the world created them.
The easiest way to trade them is by using CFDs, or Contracts For Difference with a quality, regulated broker like BUX. Instead of boring you with CFDs now, you can Learn How CFDs Work here.
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