What are indices and how do you trade them? 

Stock indices are among the most traded CFD markets, offering broad market exposure, high liquidity, and an efficient way of expressing a macro view in a single trade. This article covers everything you need to know — what indices are, how index trading works (including weightings and calculations), how to trade them, and the key risks to consider.

Key Takeaways

• Indices track the value of a basket of shares and are used to benchmark markets and trade broad themes.

• With CMC’s CFDs, you don’t trade a stock index directly. Instead, you use derivatives like CFDs that mirror index movements.

• Most indices are capitalisation-weighted (some are price-weighted), which impacts how constituents influence index moves.

• Drivers include macro data, interest-rate expectations, earnings season, sector rotation, geopolitics and more.

What are indices?

An index measures the performance of a group of stocks. Examples include the 200 largest companies on the ASX by float-adjusted market capitalisation (ASX 200) or the 500 large-cap US companies in the S&P 500.

By turning a variety of share prices into a single number, indices provide a way to benchmark market performance and track broad trends. They can also be grouped by region (US, Europe, Asia), sector (technology, financials) or company size.

^{Past performance is not a reliable indicator of future results.}

How does index trading work?

You can’t buy an index outright because it’s a benchmark, not a tradeable asset. However, you can gain exposure to an index’s performance through instruments such as ETFs, futures, or CFDs that track its movements. With a CFD, you go long if you expect the index to rise or short if you think it will fall. Profit or loss depends on the direction of your position and the size of the move in the index-based instrument.

With CMC Markets, you first select indices in the product library, choose your market, pull up a chart, apply indicators/drawing tools, and place an order with risk controls attached.

How are indices calculated?

Indices are calculated and weighted in different ways, and this is usually down to the managing company (such as index providers like S&P, FTSE and MSCI). Here are some common methods used:

• Equal-weighted: constructed by putting the same amount of capital into each stock, so they have equal weight within the portfolio.

• Market capitalisation-weighted: made up of a set number of companies that have the highest market value. These tend to have a higher impact on the overall value of the index.

• Price-weighted: gives the most weight to stocks that are priced the highest. Stocks priced the lowest will have the smallest effect on the index.

They can be rebalanced periodically, such as daily, weekly, monthly, or quarterly, to ensure that the weighting of each stock is in line with its formula and objective.

The value of an index can be influenced by various factors, including constituent company performance, broader economic indicators, and market sentiment. In order for a company to be added, it could be selected by a committee, as is the case with the S&P 500. The committee will consider the eligibility of each new addition based on strict criteria, such as market capitalisation, financial viability and the length of time it has been publicly traded on the stock exchange.

What are the most popular global indices?

Here are the most traded global indices and their main constituents:

Note: Index composition, weighting, and naming conventions may change over time as companies grow, merge or are removed from a benchmark. For example, the DAX 30 expanded to the DAX 40 in 2021 to better reflect the German equity market.

What are the factors affecting the prices of indices?

Index levels respond to a mix of top-down and bottom-up forces:

• Macroeconomics: Inflation, unemployment, GDP and more can steer interest-rate expectations and risk appetite.

• Central-bank policy: Rate decisions and guidance (hawkish/dovish) can reprice equity risk premiums quickly.

• Earnings season: Aggregate beats/misses and outlooks drive sector rotation and index trends.

• Sector/commodity dynamics: Such as tech leadership in the US, or commodity swings influencing the ASX 200.

• Geopolitics and news: Trade tensions, fiscal policy and election risks affecting sentiment and volatility.

• Volatility gauges: Some traders monitor indices like the VIX to contextualise risk conditions.

Why trade indices?

1. Broad market exposure: A single position can potentially provide exposure to market-wide themes, such as growth and policy pivots, without single-stock event risk. 

2. Two-way trading opportunities: Indices can provide opportunities to trade both rising and falling markets. 

3. High liquidity: Major benchmarks often feature relatively deep liquidity and tighter spreads compared with individual shares. 

4. Portfolio diversification: Indices may complement a portfolio of individual shares and other asset classes, potentially enhancing portfolio diversification. 

Risks and considerations of trading indices

• Market volatility: Some traders view index trading as less concentrated risk than single-stock trading, although indices can still experience significant volatility. 

• Leverage risk: The use of leverage can amplify losses and cause traders to lose their entire deposit if a trade is unsuccessful. 

• Trading derivatives: You are trading a derivative instead of a physical asset. A derivative is an instrument that obtains its value from the price of an underlying asset, such as an individual stock or stock index. The risk is that the movement of just one stock or security could have a major impact on the overall value. 

• Research and risk management: It’s important to do some research prior to trading indices and make use of risk-management tools to protect your positions against sudden market moves. These include stop-loss orders, which close a losing trade once the price passes a trigger value pre-decided by the investor, and guaranteed stop-losses, which can help protect positions in the event of sharp price action. 

How to trade indices with CMC Markets Australia

With CMC Markets’ CFDs, you don’t trade on or invest directly in the global index. Through CFDs, you can trade on derivative instruments that are based on the FTSE 100 and more. Traders can take a position based on whether they think the value of an instrument will rise or fall, and subsequently make a profit or loss depending on which way the markets move.

Step-by-step guide:

1. Fund your trading account or practice with virtual funds on a demo account first: Within the product library on the platform, select ‘Indices’.

2. Choose an index to trade: We offer 80 indices that are based on indices like the FTSE 100 and more.

3. Click on the index name to bring up a chart: Here, you can customise by chart type and timeframe​, and add technical indicators and draw tools for technical analysis.

4. Pick a strategy: Decide whether you want to go long (buy button) if you think the index will rise in price or go short (sell button) if you think it will fall.

5. Input the relevant fields: This includes order type, entry price, and how much you are willing to risk per point of movement (spread betting account) or position size (CFD account).

6. Control risk on your trade: Many traders opt to use stop-loss orders to help control losses.

7. Place the order and monitor: You may decide to hold your position if you are making a profit, or adjust or close your trade if you are experiencing a loss in order to protect your capital. Remember that all your deposits are at risk, so you should ensure you are comfortable with the risk management tools available on the platform.

Start trading indices with CMC Markets

Now that you know what are indices and how to trade them, you may choose to express a macro view through index trading, choosing a benchmark, analysing drivers, sizing appropriately, and managing risk with careful discipline. You can explore index trading concepts further with a demo account to familiarise yourself with platform features.

This article provides general information only. It has been prepared without taking account of your objectives, financial situation or needs. It is not to be construed as a solicitation or an offer to buy or sell any financial instruments, or as a recommendation and/or investment advice. It does not intend to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any financial instruments. You should consider your objectives, financial situation and needs before acting on the information in this article. CMC Markets believes that the information in this article is correct, and any opinions and conclusions are reasonably held or made on information available at the time of its compilation, but no representation or warranty is made as to the accuracy, reliability or completeness of any statements made in this article. CMC Markets is under no obligation to, and does not, update or keep current the information contained in this article. Neither CMC Markets nor any of its affiliates or subsidiaries accepts liability for loss or damage arising out of the use of all or any part of this article. Any opinions or conclusions set forth in this article are subject to change without notice and may differ or be contrary to the opinions or conclusions expressed by any other members of CMC Markets.