trading indices

The Best and Worst Forex Trading Strategies

The Best and Worst Forex Trading Strategies

Strategies in Forex market operations are a fundamental part of being able to achieve success, since without one, you will find yourself adrift and simply gambling with your money.

 

Having a strategy provides security and discipline. Finding the perfect strategy is not easy, it requires tests and time to be invested. Of course, just having a strategy does not mean that you are assured of success; on the contrary, using a not-so-good strategy can make you lose a lot of money. Next, we will explore various strategists who, after being tested and analysed, can be classified as bad or good strategies.

Please note that this is only a very brief overview, to see in-depth analysis and education, you will need to find our writings where we discuss specific trading techniques.

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Normally when discussing the different strategies available in the Forex market, they focus on a specific trading method that unfortunately is nothing more than a facet of a complete trading plan and does not represent the entire negotiation process itself.

This leads us to wonder: How do I know how good a Forex strategy is? Well, the answer lies in the fact that if the strategy is advantageous and consistent then it is good.

 However, you must have in mind other aspects of the strategies so that you’ll make sure that you are following the right path.

– Position’s size

– Risk Management

– Ways to exit a trade

A good strategy will depend massively on the type of trader that executes it, since the trader has the responsibility to understand his personality as a trader obtaining from this self-study the right amount of  knowledge to find the best Forex strategy that can adapt to its needs.

 

Therefore, we will focus on simple, basic and generic strategies that adapt to any type of trader. Here at The Doji Trader, we believe that psychology and personality play a huge role in the success of any trader, if you would like to find out more information on this, please click here.

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By using this strategy, you gain an advantage in the 60-minute time frame when you enter the market. The currency pairs that are usually traded using this technique are EUR / USD, GBP / USD, USD / JPY and the AUD / USD.  

 

To make good use of this technique, you must make use of an impulse indicator of 100 pips, as well as indicator arrows; tools you can find in MetaTrader 4.

Buying with this Strategy

The pips indicator will give you the signal when it is the right time to use it, it will be when the Momentum 100 pips indicator activates a buy signal and the blue line is ready to cross the red line from below. Once that is ready, the stop loss should be placed just below the red line of the indicator. Once these steps have been followed, the trade can be closed after 30 pips.

Now, if you want to sell, then you will have to enter a short position just at the moment when the 100 pips Momentum indicator activates a sale signal when its blue line crosses the red line from above and the Indicator arrows proceed to give a red arrow sign.

 

Finally, you must place the stop loss on the red indicator line and once this is finished, you must proceed to close the operation at the moment when the indicator arrows give a green arrow signal.

The purpose of this strategy is to capitalize on some unique opportunities to be obtained through the additional volatility obtained when London opens. Despite being a very specific technique, it is also very good. It can be used at any time, especially when the price drops sharply in one direction, it also allows you to return from a very strong support / resistance area.

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Although most currency traders prefer to do their intraday trades, since market volatility generally offers more positive opportunities in narrower terms, usually the weekly currency trading strategies can provide more flexibility and stability.

For example, a weekly candlestick can provide you with a lot of market information. This contains five daily candles and changes that give visibility to trader on the real market trends. Then, all weekly strategies are generally based on lower position sizes thus avoiding excessive risks. 

 

 In order to use this strategy, the use of the exponential moving average indicator is used. Then, the last daily candle of the previous week must be closed at an objectively higher level than the exponential moving average value. Once this happens, you should look for the moment at which the maximum level of the previous week is broken, then proceed to place a purchase order in the closed H4 candlestick, considering that it must be at the level price level broken.

These types of strategies are useful as most of the breakdowns do not usually become long-term trends. Therefore, a trader who uses this type of strategy has the objective of obtaining an advantage of the tendency of prices to recover both in the maximums and in the minimums that were previously established.

 

These are considered the best Forex trading strategies, because they generate a lot of confidence among traders because of their high success rate.  

In all types of markets, we will many techniques that are not as feasible or advantageous as others. It is important to keep in mind that if we find offers from people online, or many trading ‘miracles’ that sound too good to be true, there is a high probability that it is actually too good to be true…

 

Below you can find some strategies that we do not recommend when trading.

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This strategy is very popular among beginner traders. It is a scam and only used by inexperienced traders and charlatans, it is unfortunate that so many will blow their whole trading accounts by following this. The plot of this technique is based on chasing your losses by subsequently adding larger operations to your already losing position in an excessive way.

It is well known that the sensation when using scalping is very good, you are the boss and trade expert. 2 pips here, 3 pips over there and you feel so excited that adrenaline can be savoured. But as on many trading accounts, you will find yourself at a disadvantage due to the spread. To be more specific, let’s see it this way: when a winner of 4 pips is hit, the market is in the duty to immediately move 5 pips and thus cover the cost of its margin / commission. This means that the spread is consuming 20% of its profits and is also amplifying its loss just before the price has moved.

 

For this same reason, it would need to beat the market by a very wide margin in order to counteract the spread that corresponds to each operation. Although it doesn’t seem like a significant loss, it will cause this minimal statistical disadvantage to deactivate your account.

However, it must be noted that we believe scalping to be one of the most effective and useful trading strategies, and it is so popular among both professional and retail traders. It is not an easy task, but if you feel up to the challenge, you can begin your path to being a great scalper right here. If you wish to scalp for profits regularly, but feel that the high spread of your account just renders your time unworthy, then why not look on our broker reviews to find out which broker is the most cost-effective?

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Knowing that not all currency pairs behave in the same way is to be a mature and responsible trader, however, not everyone manages to be that way. Each currency has its own peculiarities, so each one will move differently, and the inhabitants of each nation will sell and buy their coins depending on their territorially political and economic situation. Therefore, decisions are made every day that will affect the movement of a particular currency in one way or another. So, this leads us to the conclusion that these types of practices (or strategies) should be used less times than recommended, there are many operators in the market who are dedicated to apply this strategy over and over again even if they don’t get results, either from boredom or despair and desire for quick success. It is critical and basic thinking, knowing that the idea of exchanging several pairs at once is a mistake and that it is best to concentrate on one and take care to study it properly.

 

Once you find a currency pair that really works for you and to which you can extract good profits, you can consider expanding your sales and purchases. Trading is often about finding where you have an edge on the market and zoning in on that specific area.

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Summary

It is always good advice to take to know that the fact that a strategy works for another person does not mean that it is equally successful for you. However, there are strategies that are usually much more general and that usually work for a good percentage of the population, which means that trying them is not a bad idea. On the other hand, if we are in front of a strategy that seems to be a fraud and that has several negative aspects, it would be best to stay away from such strategies, to avoid unpleasant moments and significant losses.

 

But the most important thing is that any strategy that you have not used before, you should try it for a while, without risking much of your capital, in order to draw your own conclusions and even customize it.

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This does not constitute investment advice or personal recommendations as your specific financial circumstances have not been considered. No warranty is given in regards to the accuracy and completeness of information. Past performance is not an indicator of future results.

Posted by Alex in Lessons

How to Eliminate Risk in Trading

How to Eliminate Risk in Trading

 Eliminating risk in trading is a large challenge for traders of all skill as well as a major reason for the majority of failures when trading. Risk could even be blamed for the reason of the most recent global financial crisis, as many bankers were trading with such large leverage. To eliminate risk could prevent future disasters both economically, and for you personally with your account.

Many have the opinion that it is not possible to eliminate risk in trading, and this is true to some extent. What you do is to manage risk. At the basic level, trading can be summed up in two words — risk and reward. If there is no risk, there will never be a reward. So, take your mind away from the idea of trading without risk.

While it’s not possible to eliminate risk from trading, your primary job as a trader is that of a risk manager. Some traders don’t take risk management seriously, but to succeed in the game of trading, you must learn how to practice low-risk trading at all times. Risk management helps you to cut short your losses to protect your trading account from catastrophe.

There are many ways to manage and minimize risk in trading, and below we show how to eliminate risk in trading:

Table of Contents

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The importance of using an honest broker cannot be overemphasized to eliminate risk in trading. No matter how good your trading strategy is and how robust your risk management techniques are, if your broker is dishonest, you will never make one cent from your trading, and the money in your trading account is as good as lost.

As a matter of fact, check the broker’s trust rating. Is the firm authorized and regulated by any of the tier-1 financial regulators, such as the CFTC, FCA, ASIC, and IIROC? How does it handle clients’ funds and are there measures to protect against negative account balance?

The worst thing that can happen to you as a trader is to have a dealing desk broker who takes the other side of your trades — there will definitely be a conflict of interest. Be sure that the broker offers ECN accounts and that your account is ECN. If you would like to find the right broker for you, why not check out our broker reviews, where we fairly weigh up the pros and cons of over 30 brokers.

Trading is a very tough and emotionally draining task, and there are no guaranteed returns for all the hard work. Returns are highly unpredictable — you will never make profits from month to month. It is better you know all these now and be realistic with your expectations.

The right way to go is to understand the nature of trading and set the right goals. In the words of Mark Douglas: anything can happen, every moment in the market is unique, and there is a random distribution between wins and losses

So, your goals should not be outcome-oriented. Instead, set execution-oriented goals. That is, to properly execute your trade anytime your trade setup appears in the market, without fear, hesitation, or pressure. To ensure low-risk trading, you must have a trading plan and follow it to the letter.

You must predefine the risk of every trade. What this means is that you have to know what you are willing to risk before placing a trade in the market. And make sure you don’t go beyond your risk tolerance. This will make it easier for you to accept a loss if it occurs.

There are different ways to define your risk exposure. One way is to know the number of pips your trade setup requires. But the ultimate thing is your account risk. How much of your account capital do you risk in a trade? It is advisable not to risk more than 1% of trading capital in each trade. You can figure out your lot size once your account risk and the number of pips to risk.

By adhering to this, it becomes easier to take a loss without losing your emotional capital, and your account will be safe from blowing up.

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After defining your risk, the easiest way to make sure that you maintain that predefined risk when you place a trade is by using a hard stop loss, instead of a mental stop loss, in every trade. It saves you the emotional battle of thinking that price may reverse after you close the trade.

A hard stop loss is automatically executed once the price reaches the level where it is. It doesn’t require you to do anything else once it has been placed, unlike the mental stop loss which requires you to manually exit the trade.

Using a hard profit target is good too. Even though it doesn’t directly help you to manage risk, it helps you to maintain a reasonable risk/reward ratio and protects you from greed and hope — two dangerous emotions for traders. We believe that emotions and psychology play a vital role in trading, to learn more, click here.

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It is very important that you do not use excessive leverage so that you don’t blow your trading account. Trading is a game of odds, and there’s no guarantee that the next trade or even the next three trades will be a winner.

So, why use excessive leverage that will burn your account fast if you have a streak of losses? The first rule in this game is to preserve your capital and the second rule is not to forget the first rule. If you have your trading capital, you will get the opportunity to win in the future

Controlling your leverage comes down to the size of your positions. How many lots do you trade at a time? How does it affect your account risk? Using bigger leverage and maintaining a 1% account risk means using a tighter stop loss, which would increase your chances of losing.

It is very important to guard against overtrading because you may get overconfident and make a costly mistake that can lead to a catastrophic loss.

When you have a series of wins, take a break from trading and go do something else to clear your head. This will help you avoid getting overconfident and taking trades that don’t meet your criteria. If you trade out of excitement or boredom, you are very likely to give back all your profit plus more to the market.

Controlling your emotions is one of the toughest tasks in trading, but you have to do it if you desire to get the most out of your trading — remember, you don’t trade for the fun of it but to make money.

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While volatility is good and helps you profit from huge price movements, it can also decimate your trading account if things go wrong. If you are new to trading, it is best to avoid extremely volatile conditions such as during high impact news.

Prices can spike wildly during these conditions that using a hard stop loss may not be helpful in some cases because of huge slippages and the possibility of price gaps, which can render the hard stop loss useless.

It is best to take a short break when some of the high impact news are being released. The U.S. Nonfarm Payroll report and central bank interest rate reports are some of the high-impact events you should avoid. 

We have created a very helpful article in trading one of the most volatile market times; the FOMC Meetings. If you would like to learn how to trade at the time of these meetings, please click here.

It is not enough to set a limit on the amount to risk on each trade if you trade different currency pairs at the same time. If you use the 1% rule for each trade but have three trades at the same time, your risk exposure is at that point is 3%.

While trading different currency pairs at the same time is not bad, make sure the pairs are not correlated. Some currency pairs (EUR/USD and GBP/USD, for example) can correlate by as much as 80%, so trading them at the same time will only multiply your risk.

Trading currency pairs that are not correlated may be a form of diversification and can help you to lower risk. Some traders even use negatively nerve-wracking pairs to hedge their position.

Trading is a tough job — emotions can run high when things are moving our way, let alone when things are not moving as we want. A series of losses can make you abandon your trading plan and start trading haphazardly, which will even lead to more losses.

So, to maintain low-risk trading, you must have a maximum number and dollar amount of daily (if you are a day trader or scalper), weekly, and monthly losses beyond which you suspend trading for that day, week, or month.

 

After a series of losses or a huge single loss, it is advisable to avoid trading and do something that will help you clear your mind and regain your emotional capital. When you are coming back to the market, start with demo-trading to build your confidence.

Many of the best traders will walk away from the screen once they have lost or achieved a certain amount of points in one trading day. This is a very disciplined practice and can keep your account at a very safe, stable growth-rate. 

Following on from the final point above, trading is a serious business that requires personal discipline. You need to create a trading plan and stick to it. Define what gives you an edge in the market and make a checklist for the criteria a trade setup must meet before you place a trade. Do the same for your exit strategy.

Don’t ever think of changing your trading plan until you have reached a sample size of at least 20 trades. Then, review the plan to see if it’s doing fine or needs some adjustments.

Being a disciplined trader helps you avoid bad trading habits, such as over-trading, revenge trading, and emotional trading. 

Final Words

It is not possible to completely eliminate risk from trading since there can be no reward without risk, but applying the tips discussed here will help you maintain low-risk trading. Without proper risk management, it’s impossible to succeed as a trader.

This does not constitute investment advice or personal recommendations as your specific financial circumstances have not been considered. No warranty is given in regards to the accuracy and completeness of information. Past performance is not an indicator of future results

Posted by Alex in Lessons

Trading the FOMC Meeting

Trading the FOMC Meetings

There are several fundamental news and economic events that can have a huge impact on the forex market, and the FOMC meeting is one of them. The anticipation and speculations in the days leading up to the meeting and the fallout thereafter cause so much volatility in the market, as traders and analysts react to decisions made in the meeting.

It is such an important event that even pure technical traders look forward to it and adjust their trading plan accordingly — temporarily stay off the market during the press conference where the key decisions in the meeting are announced or formulate strategies to benefit from the increased volatility during the period.

Before looking at how to trade the FOMC meeting, let’s find out what the meeting is all about.

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FOMC is the acronym for the Federal Open Market Committee, which is the branch of the U.S. Federal Reserve Bank that supervises the direction of the monetary policy of the United States. Members of the FOMC include seven governors of the board and five presidents of the Federal Reserve Bank.

Eight meetings are scheduled for the FOMC each year. The purpose of each meeting is of twofold:

1) Previewing existing economic data

2) Deciding the necessary intervention based on the economic data.

What Happens During the Meetings?

During the meeting, the committee deliberates on several issues about the U.S. economy and the global economy. The committee considers a lot of economic data, including the growth of household spending, job gains, unemployment rate, wage increase, inflation, and business fixed investments.

After carefully considering all these data, the committee decides on the Federal Fund Rate and money supply. Fund Rate is the short-term overnight interest rate that banks charge each other for loans and deposits with the Fed, and this rate dictates the medium-term and long-term interest rates. The Fed’s decision on money supply affects the sale of U.S. Treasury Bills and bonds.

Meetings are closed to outsiders, and only the seven governors of the board and the five Federal Reserve Bank Presidents are in attendance. Shortly after the meeting is concluded, a press conference is held, and the general outcome and the key decisions are announced. However, the minutes of the meeting are not published until three weeks after the conclusion of the meeting.

How do the Markets React?

Market reaction to the decisions reached during the FOMC meeting can vary dramatically, but it is generally based on the prospects of changes in the interest rates. The FOMC’s position on whether or not to intervene in the U.S. economy has far-reaching effects even outside of the US. Being the largest economy in the world, whatever affects the U.S. market also affects the rest of the world. Moreover, other central banks take a cue from their U.S. counterparts.

The Fed usually targets an annual inflation rate of 2%. So, depending on whether it wants to slow inflation or drive it up to balance out the money supply and ensure price stability, the FOMC may introduce policies to raise interest rates or lower them. In essence, the outcome of the FOMC meeting gives traders an idea of the official view of the U.S. economy.

Probably the most important indicator of the U.S. economic health, alongside the Nonfarm Payroll report, the FOMC meeting is keenly followed by traders all over the world. Many traders, especially the fundamental traders, make use of the FOMC decision to design a framework for their trading strategies.

Technical traders also pay great attention to the decisions of the committee because of the volatility it generates in the markets. Some technical traders tend to stay away from the market during the post-meeting press conference and when the minutes are published.  However, others love the increased volatility and formulate strategies to trade the event.

Decisions from the FOMC can have a direct impact on several aspects of the U.S. economy and the markets that rely on the economy. So, the effects can be felt in different markets or asset classes, including:

1) Forex markets

2) Bond markets

3) Equity markets

4) Commodity markets

 

Forex Markets

Decisions of the FOMC have a serious impact on the forex market because most of the major currency pairs have the USD as either the base or the quote currency. When the FOMC increases interest rates, the value of the USD increases because more foreign investors will be attracted to the U.S. economy. Conversely, when the interest rates are lowered, the value of the USD is likely to decrease.

Bond Markets

Bond markets are highly dependent on the prevailing federal rates. Bond prices and yields have some inverse relationship with each other and the interest rates. When the interest rates increase, bond prices fall, and yields increase. On the other hand, when interest rates fall, bond prices rise, and yields decrease.

Equity Markets

Interest rates affect the way businesses and consumers can borrow money. When interest rates are increased, people tend to have less disposable incomes to buy shares, leading to declines in prices. This is due to less demand for certain shares. When the interest rates are low, people can easily borrow money to invest in stocks, so stock prices often rise.

Commodity Markets

Commodities (such as gold, silver, and other precious metals), tend to have an inverse relationship with the USD. So, when the interest rates are low and USD is weak, those commodities tend to rise in value. Conversely, when interest rates are high and the USD is rising in value, the value of those commodities often decreases. Also, investors see those precious metals as safe-haven assets to buy when the economic outlook is looking gloomy.

Increases in volatility occurs during the FOMC meeting press conference, and when the minutes are released, may present some trading opportunities. Scalpers and day traders may formulate some strategies to benefit from the increased volatility that occurs around the time of this economic event.

However, trading during a period of increased volatility can also be very risky. If the price goes against your position, you can lose a lot of money. Even if you’re using a stop loss or a trailing stop, the price movement can be very dramatic that the slippage may be more than you can handle.

Speculation Prior to Meetings

In the weeks leading up to an FOMC meeting, speculation as to what the Fed’s decision will be is common, so more often than not, the market may have already priced in the interest rate adjustments expected from the meeting, by the time the outcome of the meeting is announced.

Unexpected Decisions - Implications

Implications of an unexpected FOMC decision is that the market reaction can be very swift and severe as volatility may increase significantly. It is often difficult to take advantage of the confusion, but if you have a good understanding of the dominating market sentiment and you are quick enough, you may be able to capture the quick price spikes that come with such surprises from the Fed.

While long-term traders may not be concerned with the price spikes that occur during this kind of economic events, they should also be aware of the fact that the FOMC decision can affect the long-term direction of the market. However, the actual effect of any adjustments in the interest rates may take time to manifest in both the economy and the financial markets. This is sometimes more than 12 months.

So, it is very necessary to take the time lag into consideration when analyzing any potential trading opportunity or making any investment decisions. Another thing to consider is the possibility of formulating a specific trading strategy for each FOMC meeting which can benefit from the price movements, irrespective of the outcome from the meeting.

You can combine the outcome of the FOMC meeting and a simple technical strategy to scalp the market in the minutes following the announcement of the FOMC decisions.

Use the 5-minute and 1-minute timeframes for this strategy and only for currency pairs with USD as the base currency. Here is what you do:

1) Put a 21-period EMA and a 100-period EMA on your chart and watch the direction of the indicators before the news release.

2) If interest rates are raised and the 21-EMA is above the 100-EMA, enter in favor of the USD and put a stop loss below the nearest support level. Then trail your profit very fast.

3) If interest rates are lowered and the 21-EMA is below the 100-EMA, enter against the USD and put a stop loss above the nearest resistance level. Then trail your profit very fast.

For currency pairs with USD as the quote currency, the opposite may work.

Final Words

FOMC meetings are among some of the most important events on any traders’ economic calendar. It is scheduled eight times in a year, and it’s where interest rate decisions are made. Its reports have some significant effects on the forex market, and the increased volatility that occurs during the event may present some trading opportunities. 

Want to find the best broker to trade with? Take a look at our top 3 brokers for traders in the United Kingdom here.

This does not constitute investment advice or personal recommendations as your specific financial circumstances have not been considered. No warranty is given in regards to the accuracy and completeness of information. Past performance is not an indicator of future results.

Posted by Alex in Lessons

What Are Indices and Where Can I Trade Them?

What are Indices and Where can I trade them?

There are many financial derivatives out there, and indices are one of those derivatives that traders and analysts follow on a daily basis. They have become a very important part of every financial market because of what they represent in the market.

 

While you cannot directly invest in market indices, there are ways to gain exposure to them or speculate on their price movements. But before we get into that, let’s find out what an index is and how it is derived.

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1) What is an Index?

An index is a measurement of the price performance of a group of securities in an asset class or a market. It consists of a portfolio of securities that represent a particular market or a section of it, and its value is calculated as a weighted average of the prices or market capitalization (in the case of stocks) of its constituent securities.

The market, here, can be the stock market, bond market, forex market, or commodity market. So, we have stock market indices, like the S&P 500 Index and the FTSE 100; the bond market indices, such as the U.S. Aggregate Bond Index; the currency market indices, such as the USD Index and the Euro Index; and the commodity market indices, like the S&P Commodity Index and the Rogers International Commodities Index.

However, stock market indices are, by far, the most common indices in the financial market. They are the indices that financial analysts talk about most of the time, and most online brokers offer their CFDs for retail trading. So, for the rest of this article, we will focus on the stock market indices.

A stock index is a statistical measure of the performance of a group of stocks listed on a particular stock exchange. Depending on the constituent stocks, an equity index may represent a section of the stock market or the whole of it.

 

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For instance, in the U.S. stock market, the Nasdaq Index, which is dominated by tech stocks, is often used as the benchmark for the technology sector of the market, while the S&P 500 Index, which consists of the 500 most capitalized stocks listed on the NYSE, is used gauge the U.S. stock market.

Apart from the S&P 500 Index and the Nasdaq Index, other popular equity indices of the U.S. market include the Dow Jones Industrial Average (DJIA), which represents 30 large stocks on the NYSE, and the Russell 2000 Index, which measures the performance of 2000 smallest cap stocks in the Russell 3000 Index — a basket of 3000 biggest U.S. stocks.

Almost every major stock exchange in the world has an index that tracks the performance of the market. For example, the FTSE 100 Index represents the 100 largest stocks trading on the London Stock Exchange. Others are DAX 30, which represents the 30 largest stocks on the Frankfurt Stock Exchange; Nikkei 225, which measures the performance of 225 large companies on the Tokyo Stock exchange; and CAC 40, which is an index of 40 most capitalized stocks listed on the Euronext Paris.

 

Many of the major stock indices are re-balanced on a quarterly basis, so any constituent stock that no longer meets the minimum criteria required to be on the index is removed and replaced by another stock that does.

The value of any stock index is derived either from the prices or the market capitalization of the individual stocks that make up the index. But whatever the underlying parameter used in calculating an index, it is weighted according to the values of the individual stocks.

For the majority of stock market indices in the world, the value of the index is capitalization-weighted. What this means is that a company whose market capitalization (the product of the share price and the total number of shares outstanding) is higher contributes more to the index’s price. An example of a capitalization-weighted index is the S&P 500 Index

On the other hand, some major indices are price-weighted. In other words, a company with a higher share price has a greater impact on the price of the index. For example, a company with a share price of $100 will have ten times the impact of a company with a share price of $10. Examples of price-weighted indices include the DJIA and Nikkei 225.

 

Since an equity index is based upon individual stocks trading on an exchange, its value fluctuates with changes in the prices of the underlying stocks. So, if those underlying stocks increase in price, the value of the market index will go up, and if those stocks decrease in price, the value of the market index will go down.

Unlike other financial instruments, stock indices cannot be bought or sold directly. They are just indicators to track overall market sentiment, and they also serve as a benchmark to measure the performance of individual stock portfolios.

 

Although you can’t buy or sell an index directly, there are trade-able financial products through which you can speculate on the price movement of an index, and they include the following:

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An index fund is a mutual fund whose portfolio mirrors a stock market index. The fund manager selects and invests in stocks in accordance with the composition and weighting of the stock index the fund is meant to tract.

 

Being a managed fund, you will have to pay a management fee if you want to invest in an index fund. But because the fund manager doesn’t spend money on researching the stocks to pick, the management fees are lower than that of traditional mutual funds.

An ETF is a fund that trades on the stock exchange and can be bought or sold through a stockbroker during the trading hours, just like a normal stock. It automatically tracks a basket of stocks that make up the fund, and it is not managed by a fund manager. When an ETF is tracking a stock market index, it is known as an index ETF.

 

An example of an index ETF is the SPDR S&P 500 (SPY), which tracks the S&P 500 Index. So, if you want to gain exposure to the S&P 500 Index, you can do that through the ETF. You will be charged a management fee though. But it’s usually lower than that of an index fund.

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Another way to speculate on a stock index is by trading the futures contracts of that index. The futures market is a huge market for speculative traders, and since index futures are cash-settled, it is very good for speculation. Additionally, futures contracts can be traded with leverage.

 

One factor that can make futures trading less appealing, especially when compared with CFDs and spread betting, is the need to roll over expiring contracts and the inherent contango and backwardation effects. Moreover, the margin requirement is generally higher than those of CFDs.

The options market offers another way to trade stock market indices. Just like index futures contracts, index options contracts are always cash-settled, so no actual stocks are bought or sold. Both traders and investors use index call and put options to speculate on the price movement of a stock index.

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A contract for difference (CFD) is a derivative product that represents a contract between a broker and a trader to exchange the difference in the value of a security, from the time a contract is opened to the time it is closed. So, the trader doesn’t at any moment own the underlying instrument but can still benefit from favorable movement in the price of the instrument. CFD trading is purely for speculation, and with its little margin requirement, it is the easiest way to trade a stock index.

This is similar to CFDs, except that the profits made from spread betting are not taxable. Unfortunately, spread betting is only available to the U.K. and Irish residents.

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While you can trade individual stocks directly on the stock exchange or through CFDs and other derivatives, trading a financial product that tracks the performance of a stock index may be a better option. Here are why it may be preferable to trade a stock index over an individual stock:

·        A stock index offers you exposure to the entire market or at least, an entire industry.

·        There’s no need to start researching individual stocks; you are only guided by the overall market sentiment to buy or sell an index product.

·        Since a stock index consists of many stocks, no one stock can cause an extreme price movement in the index, so the price movement tends to be a lot smoother.

·        Most major stock indices are derived from the biggest stocks on an exchange, so there is enough activity in the underlying stocks to provide adequate volatility in an index, offering speculators numerous trading opportunities.

 

·        For an investor, a stock index (through an index ETF) is an easy way to gain access to a diversified stock portfolio because it is made up of several stocks.

Summary

Indices are indicators that track the performance of a financial market or a sector of the market by measuring a basket of securities in that market. Stock indices are more popular than others. Whilst you cannot buy or sell indices, there are several ways to trade them.

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This does not constitute investment advice or personal recommendations as your specific financial circumstances have not been considered. No warranty is given in regards to the accuracy and completeness of information. Past performance is not an indicator of future results.

Posted by Alex in Lessons