How to trade indices CFDs
Learn the basics of trading indices CFDs, including what they are, how they work, and why traders love them!
* Trading is risky. Your capital is at risk.
Key takeaways
Indices CFDs are a quick, convenient, and cost-effective way to trade an overall market.
Indices CFDs are ideal for diversification and risk distribution offering exposure to a range of assets across a specific sector or an entire economy in a single trade.
You can enter both ‘long’ (buy) and ‘short’ (sell) positions to maximise opportunities for returns.
Margin and leverage in indices CFD trading means you need less capital for large trades.
Like all leveraged products, indices CFDs are complex instruments and come with a high risk of losing money rapidly.
What are indices CFDs?
To define indices CFDs, let us first consider their two parts individually: indices and CFDs.
Indices
Indices, also known as indexes, are financial instruments that represent a collection or portfolio of related assets, such as stocks from various companies. Imagine an index as a virtual basket that holds a variety of assets rather than relying on just one specific asset. Instead of following the performance of a single company's stock, the index "tracks" or measures the overall performance of the entire group of assets it represents. The assets are grouped together based on certain criteria such as prominent national companies, a specific sector or an entire economy. For example, the well-known S&P 500 (US500) comprises 500 of the largest companies listed on US stock exchanges.
Mini indices provide the same exposure as the main index but offer smaller lot sizes, so they cost less than their 'major' counterparts. Minis are a great option for new or cautious traders to 'test the waters' of trading indices CFDs with less capital. It's easy to spot a mini index with FXTM, as they have an '_m' at the end of their name. For example, the mini version for the S&P 500 is US500_m.
CFDs
CFDs is the abbreviation for Contract for Difference, a form of derivative trading. A derivative is a financial contract between two parties that takes its value from the price of an underlying asset, like the indices.
Essentially a CFD allows you to speculate and potentially profit from changes in the asset’s price - both increases and decreases, depending on your position - without owning the asset itself.
Indices CFDs are a form of derivative trading specifically for indices, which track the overall performance of a collection of stocks and not an individual asset or commodity.
How are indices weighted and valued?
The value of an index is calculated based on its weighting. The type of weighting is usually determined by the index’s managing company. Two weighting methodologies commonly used are price and capitalisation. Let’s start with price.
Price-weighted index
In a price-weighted index, each company's stock is weighted by its price per share, and the index value is an average of the share prices of all the companies. The higher the price of a stock, the greater the weighting of that stock within the index.
For example, let’s imagine there’s a stock index called ABC Index and it’s comprised of 5 companies with the following names and share prices.
To calculate the index value, we add all the share prices together and divide by the number of companies included in the index.
Because Business B has the highest share price, it has a greater weighting than Company A and Corporation C. This means that any movement in the share price of Business B will have a greater impact on the overall index value than changes in the share prices of Company A or Corporation C.
The Dow Jones and the Nikkei are examples of price-weighted indices.
Capitalisation-weighted index
In a capitalisation-weighted index, also known as cap-weighted, the stocks are weighted relative to each company's market capitalisation, or market cap.
The total number of outstanding shares is multiplied by the market price to calculate market cap. The index is then weighted proportionally to each stock’s market cap as a percentage of the total market cap of all included stocks.
Let’s look at our example of the imaginary ABC Index again. This time, the companies are listed with their outstanding shares and market price.
In this instance, Corporation C has the highest weighting as it has the highest market cap of the companies included within the index, despite a lower price per share. A change in the market share price for Corporation C would have a bigger impact on the index's performance compared a change in any of the others.
The S&P 500 and the Nasdaq are examples of cap-weighted indices.
Benefits of trading indices CFDs
Arguably one of the primary benefits of trading indices CFDs is the ability to profit from both rising and falling markets.
With CFDs, you can take long (buy) or short (sell) positions, allowing you to potentially benefit from both upward and downward price movement.
Whatever direction the markets are heading, CFD indices always provide opportunity.
Leverage and margin
A key advantage of trading CFDs is that you only need to deposit a small percentage of the total trade value, known as margin.
Unlike traditional stock trading, where you’d need to own the physical shares, CFDs allow you to speculate on indices without owning the underlying assets.
Using margin gives you greater exposure to the market because profits and losses will be calculated based on the full position size, not only the funds used as margin.
Let’s say you wanted to buy $100 worth of stocks. Typically, you’d have to pay $100 for the asset. But if you had a leverage of 10:1, for example, you’d only have to place 10% of your total trade value down as capital, in this case being $10. So, you still have the advantage of the higher trade value, but with less capital required.
Leverage is higher with indices CFDs than with traditional trading.
Using a smaller portion of your capital when opening a position allows for potentially greater returns. The crucial aspect to remember is that leverage carries equal risk to amplify losses. As such, it’s essential to understand the risks of margin and leverage and apply effective risk management strategies to prevent significant losses.
Diversification
Indices CFDs provide access to a wide range of assets representing different sectors, multiple companies or countries in a single trade. This allows traders to diversify their investments across various markets and industries, potentially mitigating the impact of any single company's underperformance on their overall portfolio.
Hedging
Trading indices CFDs can be used as a hedging strategy to offset potential losses in an existing portfolio. For example, if you have a portfolio heavily weighted in specific sectors, you can take a short position on the corresponding index CFDs to hedge against potential downturns.
Lower costs and fees
Trading indices CFDs eliminates certain costs associated with traditional stock trading, such as stamp duty or stock exchange fees. This cost advantage makes indices CFDs a cost-effective option for traders looking to participate in the performance of stock market indices.
Liquidity
Major indices tend to have high liquidity, meaning there is usually a significant volume of buyers and sellers in the market. This ensures that traders can enter and exit positions quickly at competitive prices without worrying about liquidity constraints.
Risks of trading indices CFDs
Potential for increased losses
While indices CFDs offer higher leverage than traditional financial instruments, helping to boost potential returns, they have the same capacity to amplify losses. The markets can also be fast-paced and volatile. In some instances, this would mean the need for a margin call, or adding funds, to maintain your position.
Spread payments
Although trading indices CFDs spares you from many of the costs of traditional trading, you are required to pay the costs of spreads at entry and exit positions. This means that it’s potentially more difficult to make small profits.
Swap costs
You may also need to factor in swaps – the cost of keeping your trade open overnight. If you enter a long position (i.e. you buy expecting the market to rise), you will need to pay a small amount of interest every night to keep your trade open. Remember to factor in the cost of the spreads and swaps when calculating profits or losses.
How do indices CFDs work?
Engaging in a contract
The CFD contract is an agreement between two parties – the trader, or ‘buyer’ and the broker, or ‘seller’. As the trader, you’ll need to decide which index to trade and whether you think the price will increase or decrease. If you think the price will go up, you’d open a long position (buy), or if you think it will fall, you’d open a short position.
How does the contract work?
As its name suggests, the contract is concerned with the difference in price. Specifically, it looks at the difference in price from when the contract is entered to when it’s exited. If your position was correct, you’d profit, and the ‘seller’ who entered the contract with you would pay you, the ‘buyer’, the difference in the price between entering and exiting prices. If, however, your position was incorrect, you’d be at a loss, having to pay the ‘seller’ the difference in price.
Calculating contract profit or loss
The key calculation to work out your profit or loss is the difference between the price at which you enter and the price when you exit, multiplied by your number of CFD units.
Calculation examples don’t take into account spreads, commissions, or swap rates.
Example of profit in a ‘long’ (buy) trade for the NAS100_m.
What happened:
- Market entered at 13300
- Stop loss set at 13000 (not triggered)
- Take profit triggered at 14300
Example of loss result in a ‘short’ (sell) trade for the US500_m.
What happened:
- Market entered at 4200
- Take profit set at 4140 (not triggered)
- Stop loss triggered at 4238
Market sentiment
Investor sentiment and market expectations play a significant role in the price movement of indices CFDs. Positive sentiment can drive prices up, while negative sentiment can lead to declines.
Economic indicators
Economic indicators, such as GDP growth, inflation rates, employment data, and central bank decisions, can impact index prices. Strong economic data may lead to higher index prices, indicating a robust economy, while weak data may result in lower prices.
You can see a comprehensive list of upcoming events and data releases using the FXTM economic calendar.
Corporate earnings
The financial performance of companies within the index can affect the index price. Positive earnings reports and outlooks from constituent companies often lead to index gains, while disappointing earnings can cause declines.
Interest rates
Changes in interest rates set by central banks can impact index prices. Lower interest rates generally encourage investment and can drive index prices higher, while higher rates can have the opposite effect.
Geopolitical events
Geopolitical developments, such as trade wars, political instability, or international conflicts, can create volatility in the markets and affect index prices. Uncertainty and negative news can lead to price declines, while positive resolutions can have the opposite effect.
Market liquidity
The level of liquidity in the market, including trading volumes and spreads, can influence index prices. Higher liquidity generally leads to smoother price movements, while lower liquidity can result in more significant price swings and volatility.
Sector-specific factors
Specific sectors within an index can experience unique factors that influence their performance. For example, regulatory changes, technological advancements, or supply and demand dynamics can impact certain sectors, affecting the overall index price.
Support and resistance
Developing the skills to identify potential support and resistance levels is a key skill that you learn in technical analysis. Both represent levels where the price seems to rise and fall to, but never surpass.
The typical strategy for trading with support and resistance is to buy when the price during an uptrend falls to the support line. The trader anticipates a bounce back towards the upward direction. Alternatively, during a downtrend, the trader sells when the price reaches the resistance level in anticipation that the index will trend downwards.
Trading the trend (trend lines)
Trendline trading is particularly useful when trading stock indices as CFDs. For instance, an index such as S&P 500 trends up over the long run.
Over time economies keep expanding. Companies innovate and embrace new technologies, which leads to long-term growth. Share prices keep rising.
There are various ways of identifying trends, such as plotting high lows and low highs or using various indicators like the Moving average and the momentum indicator.
Moving averages
Using moving averages to trade indices helps you pinpoint the overall trend of the market without the noise of day-to-day price movements.
Moving averages can be defined as lines that are based on the average closing price over a given time frame.
There are various popular time frames used for moving averages, including 10 days, 20 days, or 50 days. The moving average provides support and resistance levels. For instance, during an upward trend in the market, the price tends to bounce upwards after testing the moving average.
Stochastic oscillators
Another simple and effective indicator to apply when trading Indices is the stochastic indicator. It's a simple tool for beginners because it entails two lines: %K and %D.
It's fundamentally used to determine if the market has been overbought or oversold.
Traders mainly look at the %D for trading signals. It's called an oscillator because the lines oscillate (move up and down) with the price movement.
There are two types of stochastic oscillators: fast and slow. The fast stochastic oscillator tends to produce more false signals as it's more susceptible to noise.
By tweaking the formula, the slow stochastic was introduced, and it smooths out the price action to produce better signals.
What CFD markets can I trade?
FXTM offers a range of indices CFDs based on some of the most popular global indices.
| Symbols & Names | Description |
|---|---|
AU200 (ASX - Australia) | The AU200 index is the blue-chip Australian stock market index, which tracks the value of 200 of Australia’s largest public companies by market capitalisation. |
FRA40 (CAC 40 - France) | The CAC 40 tracks 40 of the most significant securities listed on the Euronext Paris. This index indicates the health of the Paris stock market and follows a cap-weighted scheme. |
HK50 (Hang Seng – Hong Kong) | Hang Seng China 50 index constituents include the top companies from Hong Kong’s stock exchange. It’s one of the major stocks indices in Asia and is cap-weighted. |
JP225 (Nikkei - Japan) | The Nikkei is composed of 225 large Japanese blue-chip companies and serves as the top indicator of the Japanese stock market. It’s weighted by price. |
SPN35 (Ibex35 - Spain) | The Spain 35 index acts as a benchmark for Spain's main stock exchange. It follows a capitalisation-weighted scheme and includes 35 of the top publicly traded companies. |
EU50 (EuroStoxx 50 - Europe) | EuroStoxx 50 comprises Eurozone stocks from 9 countries but is mainly dominated by French and German companies. Stocks featured are of blue-chip market leaders in key sub-sectors. |
UK100 (FTSE 100 - United Kingdom) | The FTSE 100 is one of the most popular indices to trade. The cap-weighted index includes shares of 100 large companies featured on the London Stock Exchange. It reflects more than 80 percent of the UK's market capitalisation and is the most regarded benchmark. |
NAS100 (Nasdaq 100 - United States) | The Nasdaq 100 index offers the CFD option of the NASDAQ-100 Index from the Nasdaq Stock Exchange, which includes 100 non-financial companies in sectors such as technology, telecom, and biotech. |
CN50 (China A50 - China) | The China A50 index, comprising the largest 50 A Share companies by full market capitalisation of the securities listed on the Shanghai and Shenzhen stock exchanges. |
US500 (S&P 500 - United States) | The US500 index consists of large-cap U.S. stocks, reflecting the American economy across all sectors. It highlights blue-chip market leaders representing various industries nationwide. |
US30 (Dow Jones - United States) | The Wall Street 30, an index, mirroring the renowned Dow Jones Industrial Average index, which comprises 30 prominent companies listed on stock exchanges in the United States. |
GER40 (DAX - Germany) | An index reflecting the DAX, an index comprising 40 major German blue-chip companies trading on the Frankfurt Stock Exchange. |
Frequently asked questions
An index measures the collective price performance of a group of shares, usually from a particular country. Indices are often used to track and compare the performance of stock markets. The performance of each index is dictated by the performance of the underlying share prices that make up that index. An index is constructed and calculated independently, sometimes by a bank or by a specialist index provider like the FTSE Group. The choice of the companies included in the index is determined by index calculation rules or by a committee. Not all indices use the same rules, however.
By using a CFD, or contract for difference, for indices trading, traders can profit from whenever prices either rise or fall. Traders can accomplish this by either opening a short (sell) or long (buy) position, depending on whether they think the index will fall or rise, respectively.