TABLE OF CONTENTS WHAT ARE INDICES? 3 HOW INDICES ARE PRICED 4 WHY TRADE INDICES? 5 HOW INDEX FUTURES ARE TRADED 6 TYPES OF INDICES 7 AN EXAMPLE OF AN INDICES CFD TRADE 8
UNDERSTANDING INDICES WHAT ARE INDICES? A stock index is the average of selected share prices that represents a certain market or sector The overall performance of these shares provides a benchmark for the trends in the industries they represent, or the stock market of the country as a whole A change in the price of an index is a reflection of the proportional change in the stocks included in the index. Charles Dow was the first person to create the most widely used stock index to date The Dow index was first established in 1896 and contained 12 of the largest publically traded companies in the US Today, the Dow Jones Industrial Average (DJIA) contains 30 of the largest US companies Stock indices cannot be traded directly as they are representations rather than products; in this sense, investors can trade indices through derivatives, such as CFDs The FTSE represents 100 companies traded on the London Stock Exchange Copyright Icon Markets Limited 2017 www.rtcfinance.com 3
HOW INDICES ARE PRICED Most indices, such as the FTSE 100, are calculated using a capitalization-weighted average In this case, the size of each company listed in the index is taken into account The more a company is worth, the more its share price will affect the value of the index as a whole prices will have greater influence. As an example, a stock trading at $150 will be given 10 times more weight than one trading at $15. 6604 On the other hand, the Dow Jones is a priceweighted index, so shares with higher With a capitalization-weighted average, the 6603 more a company is worth the more its share price will affect the index 6602 6601 6600 $100 With a capitalization-weighted average, shares with higher prices have more influence on the value of the index. A stock traded at $100 has 10 times the effect on an index value than a stock traded at $10. 4
UNDERSTANDING INDICES WHY TRADE INDICES? Access to over 30 international indices From the Nasdaq and Dow Jones in the United States, to the CAC and DAX in Europe and the Nikkei in Japan, you effectively have access to all the major indices around the globe Low margin rates You can gain exposure to your market of choice, even with limited investment capital Remember, however, that leverage also comes with increased risk as with any other investment opportunity Short-term trading By trading indices futures, you can gain exposure to volatility trading with the potential of making small, but regular profits from a volatile market Low spreads You can take a position on your stock index of choice from only 1 point, even with major indices such as the FTSE 100. Hedging against losses If you ve invested in multiple shares, you can limit your investment risk exposure by opening an opposite position as an index future For instance, if you have multiple short shares positions, you could take a long position on an index future Doing so will help to offset losses if the shares moved against your favor S&P HOW INDEX FUTURES ARE TRADED Index futures are the primary way to trade stock indices All indices have futures contracts that are traded on a futures exchange, such as the E-mini FTSE 100 that is listed on the FTSE 100. As a trader, you have the option to either take a long or short position on the future price movement of a given stock index Entering a long position Copyright Icon Markets Limited 2017 www.rtcfinance.com 5
This entails buying the index at a fixed price now, for an expiry that is set at a future date. Taking a long position means you expect the index price to increase by expiry so that you can make a profit by selling at a higher price than you paid. Entering a short position This entails selling the index at a fixed price now, for an expiry that is set at a future date. Taking a short position means you expect the index price to decrease by expiry so that you can make a profit by buying at a lower price. Index futures are traded on leverage, just like other futures markets You put down a margin of your contract s total value in order to increase your exposure in your market of choice TYPES OF INDICES GLOBAL INDICES These cover some of the world s largest publically traded companies As an example, the MSCI World index measures 1500 stocks from every developed market around the globe and is often used to gauge international stock funds NATIONAL INDICES National indices represent the performance of stocks in a specific country. For instance, the FTSE 100 measures the top 100 largest companies listed in the London Stock Exchange (LSE) SECTOR INDICES 6
UNDERSTANDING INDICES These are specialized indices that are geared to specific sectors, such as the Morgan Stanley Biotech Index, which tracks the biotechnology industry CURRENCY INDICES COMMODITY INDICES The Continuous Commodity Index measures 17 commodity futures that are perpetually rebalanced The US Dollar Index calculates the value of the US dollar against other foreign currencies CACSMI SENTIMENT INDICES The CBOE (VIX) Index s measurements are obtained from the S&P 500 prices and reflect the expectations of near-term volatility. HANG SENGS&PFTSE DOW JONESDAX NASDAQ ALL ORDINARIES MIBNIKKEIIBEX AN EXAMPLE OF AN INDICES CFD TRADE SELECT AN INDEX You re interested in trading a FTSE 100 Cash CFD. Our price is currently set at 6531.5/6532.5, priced in points. BUY OR SELL You choose to sell 1 contract at the bid price of 6531.5 because you believe the market will drop. Alternatively, you could buy 1 contract at the offer price of 6532.5 if you believe the market will rise MARGIN CALCULATIONS The value of 1 contract for a FTSE 100 trade is 10 EUR. Every point that the market moves will be worth 10 EUR, whether it is in your favor or against it. The margin requirement for 1 FTSE 100 contract is 0.5% of the trade. For one contract worth 10 EUR per point at a price of 6531.5, the notional value would be 10 EUR x 6531.5 = 65,315 EUR. The margin requirement would be 65,315 EUR x 0.5% = 326.58. This amount will need to be available in your account prior to placing a trade Copyright Icon Markets Limited 2017 www.rtcfinance.com 7
CLOSING YOUR TRADE At 3pm, the FTSE 100 drops, and the FTSE 100 Cash CFD price is now set at 6410.5/6411.5. You choose to close your trade by placing a buy trade at the offer price of 6411.5 YOUR PROFIT / LOSS Profits are calculated according to the difference between the opening and closing prices in points In this case, 6531.5-6411.5 = 120 Because you sold 1 contract worth 10 EUR per point, your profit would be 120 x 10 EUR = 1200 EUR. If the market had risen in value, you would have sustained a 1200 EUR loss. 8