Stock market indices are in the spotlight nowadays, especially as markets such as the USA or Germany are reaching new all-time highs. When putting indices head-to-head with individual stocks, several differences will come out. That is why a brief guide into how to trade indices this year is required, serving as a useful tool for traders in need of assistance.
Intro into indices
An index is an average of a basket of stocks. DAX30, Dow Jones Industrial Average, CAC 40, or FTSE 100 are all very popular indices, benefiting from large daily inflows and high liquidity. Another important aspect to consider is that stocks that are usually integrated into an index are “blue chips”, or companies with a dominant market share in their respective field.
The goal of an index is to show an overall picture of a whole market, even though in reality, it only shows how a limited number of stocks are performing on average. However, due to low trading costs and accurate trade execution, trading indices or other related derivatives like CFDs are now popular among retail traders.
Main differences as compared to stocks or FX
Compared to currency pairs or individual stocks, it is important to note that an index is an average. Calculation methods might be different, yet how the index will perform will depend on how the underlying stocks will move. This creates a very liquid environment and thus daily ranges will be very tight.
Individual stocks are very volatile as compared to indices and that might not be suitable for traders with low risk tolerance. Indices trading can be a useful approach for those that still need to develop trading skills and would like to keep their downside risk in tight control.
Indices volatility is similar to the one currently seen in the FX market. A trader with exposure to various markets (commodities, stocks, FX) can use indices to balance the overall portfolio volatility or to hedge exposure when markets are dropping.
To trade indices effectively, traders can use the same trading tools as with any other major asset class. Moving averages, Fibonacci levels, oscillators, or other proprietary trading strategies can work in such a liquid environment. Tight daily ranges will also mean traders can place more accurate trades and keep risk limited using a stop loss or other risk management tools.
Volatility is reduced and that puts an upside bias on all indices. “Buy the dip” seems to be the main approach, as fiscal and monetary stimulus, combined with the transitory inflation narrative, are both supporting a continuation of the major bullish trend.
Even though the upside is still intact, issues like growth concerns, inflation, or COVID-19 headlines can put downward pressure on indices. Thus far the market managed to brush aside all worries and each retracement lower turned out to be a buying opportunity. The persistent uncertainty puts indices in a favorable position as traders and investors want exposure to the dominant companies.
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