Indices measure a collection of assets: currencies, commodities, stocks, bonds, ETFS and more. Since indices reveal the performance of these assets, when an investor trades indices they stand to gain a macro view of the overall market. Through indices, a trader is also able to compare the profitability of multiple assets.

A good example is the S&P 500 or Standard & Poor’s 500, a stock index which comprises a group of the 500 largest publicly traded companies in the U.S. The stocks it encompasses are from 11 sectors of the U.S. economy. Meaning, any trader holding a position based on the S&P 500 gets visibility to give or take, 80% of the U.S. market stocks’ entire value. It makes sense then, that when traders ask about market conditions for the day, they are really asking about how the S&P 500 is doing.

Investing in indices is a great option for those wanting to foray into trading because it is a passive method of investment. In fact, it’s one of the most common forms of passive investment strategies. In a way, it makes the most out of a trader’s investments with the trader not having to do as much trading in the market. Generally, when traders opt for such strategies, they hold long positions intended for long-term returns.  

Learn How to Trade Indices on MetaTrader

When trading indices, the common objectives are for a trader to assess the performance of their portfolio in comparison to other assets, to measure the price performance of a basket of securities, and to gauge market confidence. Indices also provide a means for low-cost investment in the form of passive index investing.

When a trader invests in indices or when ‘indexing’, they set up a passive fund portfolio. Instead of setting up a fund portfolio for the purpose of active trading, a fund portfolio manager uses it to mirror an index under which lie several assets. For example, this fund manager could be holding exchange-traded funds (ETFs) and mutual funds in their portfolio. By mirroring popular stock indices like the S&P 500, NASDAQ-100 or any other world market index, fund managers hope to replicate the success of the indices.   

Trading indices can also be done using Contract for Differences, or CFDs. With CFDs, a contract is formed between buyer and seller wherein the former will pay the latter the price difference between the open and closing prices of a trade. Through CFDs, the parties involved can profit from market price movements without owning any underlying assets. An electronic trading platform like MetaTrader 4 (MT4) or MetaTrader 5 (MT5), developed by MetaQuotes Software, makes trading indices with CFDs easy with features like live charts and asset prices which also allow for prompt and efficient order placements.

ZFX, a financial brokerage providing trading services for multiple financial instruments, is a licensed MetaQuotes Software broker. Their ZFX MT4 platform is one of the easiest to start trading indices with for an initial fund of $50. For more on how to trade stock index CFDs with the MT4 platform or just trading CFDs for that matter, visit their website here.  

There are millions of stock indices to choose from and what sets apart the top ones from the rest are asset company location, how many companies are included in the index and the industry that the companies belong to, among others.

Below is a list of the top world market indices.

Top Major World Indices in 2023:

1. NASDAQ-100
2. S&P 500
3. Hang Seng Index
4. FTSE 100
5. DowJones Industrial Average
6. DAX 30
7. Russell 2000
8. CAC 40
9. EURO Stoxx 50
10. Bovespa Index – Ibovespa (Índice Bovespa)

The First-Ever Stock Index

The Dow Jones Index is the first ever index to have come into existence back in 1896. To this day, it’s still the most recognisable. Back in the day, it had a mere 12 shares and calculating the Dow Jones’ value was simple. It was done by totalling up the prices of the 12 shares and then divided by 12. This calculation method may have sufficed in the days without computers but today where more aspects need to be factored in, calculation methods have come a long way.

The 2 calculation methods:

There are more than two ways to calculate stock indices, but the main ones are:

• Price-weighted: This is the same method used to calculate the Down Jones Industrial average. Share prices in an index are added up and then divided by the number of shares contained in an index. However, this method was found to be not as accurate due to companies not issuing the same number of shares in an index. For example, in an index, Company A could have a few million shares while Company B could have much less in comparison, in the thousands.
• Market Capitalisation-weighted: This method is used to calculate the S&P 500’s average index. The value of the S&P 500 is derived from market capitalisation of the companies that are part of it. A company’s market capitalisation can be calculated by multiplying the company share price with its total number of shares outstanding. A company’s weighting in the index is then calculated by dividing the company market capitalisation by the S&P 500 total market capitalisation. The larger a company’s weighting, the more influence it has on the index.  

Price Action in Index Trading

Whether the easiest or the best indices to trade, the US Standard & Poor’s 50, or the S&P 500; US Dow Jones Industrial; and US Nasdaq are top among the recommended indices for indices trading. For the S&P 500, it’s due to asset diversity, the US Dow Jones because of its history as the oldest index, and the US Nasdaq indices (Nasdaq 100 and Nasdaq Composite) are known to include giant tech companies in their portfolio.

Indices cannot be traded directly like individual stocks. The performance of an index is merely used as a benchmark based on which other assets can be traded. For example, assets like futures and options can be traded based on the performance of stock indices. Anytime an investor says they are going long or short on the S&P 500, they aren’t referring directly to the index. Instead, they are long or short on a futures or options market.

The beauty of using stock indexes as benchmarks is that through the use of one or two reference points, a view on the majority of financial markets can be attained. Having well-grounded bellwethers in trading and investing is one of the determinants of success.   

Price Action being a fundamental to any kind of investment strategy, and especially in trading, it’s important that an investor understands the factors influencing index prices.

These factors are included in but not limited to the list below:

• Economic news: This can affect investor sentiment, central bank announcements and payroll reports among several others when it comes to the performance of stock indices. Any change in the aforementioned factors can impact underlying volatility and hence, trigger index price fluctuations.
  
• Company financial results: A company’s profits and losses will cause share prices, supply, and demand to rise or fall. These will bring about price movements in individual stocks of indices and by extension, the price of the indices.  
  
• Company announcements: Company leadership shifts or potential mergers will almost certainly affect share prices. Depending on investor sentiment and other economic news, these will have a positive or negative impact on an index’s price.
  
• Changes to an index’s composition: Every time any adjustments are made in an index portfolio, such as when companies are added or removed, the prices of weighted indices can change. This happens as traders adjust their positions to account for the new composition.
  
• Commodity prices: The commodity market can also impact index prices. Commodity stocks comprise 15% of the FTSE 100’s listed shares. Thus, price actions in the commodity market carries some weight on index price movements.

Market Watch for Stock Indexes

Futures traders rely on the Commitments of Traders (COT) Report for an overall view of the futures market. The report is a weekly publication of the aggregate holdings of U.S. futures market participants. It helps as a market signal on what to trade on and is published by the Commodity Futures Trading Commission (CFTC) every Friday at 3:30 Eastern Time.

The COT Report is viewed by futures traders as a vital source for the futures market’s price trends, and its importance is further emphasised by its use in academic research for price trends as well. Apart from observing stock indices performance, a COT Report can give further insight on trader behaviour in the futures market. Also considering its weekly publication, the weekly view on trader positions it allows is a consistent point of reference for informing investors in their speculation of market trends.  

The COT Report is meant to uphold market transparency, but some observers do find issue with its rules and accuracy. For instance, the report categorises traders as commercial and non-commercial which applies to all commodities traded. If an oil company opened both small.i.e. small hedge and large positions, both would fall under the commercial category. So, its accuracy is in question by some critics. However, it’s still a good supplement to following stock indices trends.

Index Trading with Small Accounts

Trading with stock indices has its appeal; what with the diverse portfolios and market accessibility offered. As of late, index trading has grown in popularity among small and new traders and trading it with a small account is possible. The best way to trade indexes with a $100 is by opening a micro stock indices account. One online broker that allows traders to start trading with a smaller deposit is ZFX. Their Micro Trading Account requires only a minimum deposit of $50 to start trading.  

A Tip for Beginners

For beginner traders excited about taking on indices trading, it’s advisable that they look into diverse portfolios. It’s worth noting too that stock indexes are highly leveraged and although this can work to one’s advantage, having a solid base in hedging, Stop-Losses and Take Profits, support and resistance levels, and other risk-managing tools should be in place first.

The advantage of having visibility to a basket of securities while trading with a small capital can be insightful for portfolio diversification. Trading indices is one of the means to beginning one’s trading career especially as it will provide beginner traders with ample training ground on understanding individual assets from multiple financial markets.  

Once a trader has a foundational understanding, picking individual stocks can be fun because they typically have better yields.

FAQs

1. What is the best way to trade indices?
   Trading indices can also be done with Contract for Differences, or CFDs. With CFDs, a contract is formed between buyer and seller wherein the former will pay the latter the price difference between the open and closing prices of a position. Through CFDs, the parties involved can profit from market price movements without owning any underlying assets.  
   
2. What are the easiest indices to trade?
   Whether the easiest or the best indices to trade, the US Standard & Poor’s 50, or the S&P 500; US Dow Jones Industrial; and US Nasdaq are top among the recommended indices for indices trading. For the S&P 500, it’s due to asset diversity, the US Dow Jones because of its history as the oldest index, and the US Nasdaq indices (Nasdaq 100 and Nasdaq Composite) are known to include giant tech companies in their portfolio.
   
3. Can you trade indices directly?
   Indices cannot be traded directly like individual stocks. The performance of an index is merely used as a benchmark based on which other assets can be traded. For example, assets like futures and options can be traded based on the performance of stock indices.
   
4. Can you trade indices with $100?
   Trading with stock indices has its appeal; what with the diverse portfolios and market accessibility offered. As of late, index trading has grown in popularity among small and new traders and trading it with a small account is possible. The best way to trade indexes with a $100 is by opening $100 is the micro stock indices account.