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Index trading refers to the buying and selling of financial products linked to indices, in an organised financial marketplace. Indices are barometers that measure the performance of stocks and other assets, and they can be traded in a number of ways, either directly through exchange-traded funds (ETFs) or passive index funds, or using derivatives such as contracts for difference (CFDs). ETFs are traded on exchanges, but other index trading methods involve derivatives or non-exchange traded funds such as passive mutual funds, making this an over the counter (OTC) market.
An index is a measurement of the performance of a group of stocks. Stock indices normally consist of a number of stocks, sometimes restricted by size criteria, and limited by their exchange listing or geography. As an example, the FTSE100 index measures the 100 largest companies on the London Stock Exchange by market capitalisation, while the FTSE ADX General measures the performance of all Abu Dhabi-listed stocks, regardless of size.
Indices are the responsibility of index providers, specialised companies that create and manage different indices. Often, they are linked to a stock exchange or another financial institution such as a credit rating agency. The latter is the case with Standard and Poor’s, who manage the S&P500 index of the 500 largest US companies. Index providers create indices, and are responsible for balancing and maintaining them, since changes in market composition and stock performance can cause companies to enter or fall out of indices over time.
The most famous stock indices track the performance of the largest global stock markets. Three of the most followed indices worldwide are the headline US indices: NASDAQ100, S&P500, and Dow Jones Industrial Average (DJIA).
Before looking into how to trade these indices, it is crucial to explore how they came about. What is the Dow Jones, for example, and how does it work? Let’s take a closer look.
The NASDAQ100, S&P 500, and DIJA focus on different parts of that US economy and so have unique price characteristics. Outside of the US, global famous stock indices include the FTSE 100 from the UK, CAC 40 from France, Nikkei 225 from Japan and Hang Seng from Hong Kong, with each stock exchange featuring a headline index that offers an overview of market performance.
UAE’s Abu Dhabi stock exchange is the ADX, or Abu Dhabi Securities Exchange. Launched in 2000, the ADX has a growing number of national and regional listings, and its headline index is the FTSE ADX General Index. This is an example of an ‘all shares’ index, where every stock contributes to the price moves of the index. ADSS clients in the UAE can use CFDs to trade a range of global indices from the top American, European and Asian exchanges.
Indices trading serves an important function in a scattered global stock market. There are estimated to be about 48,000 publicly traded companies worldwide. The Japan Exchange Group, which runs the Tokyo Stock Exchange, is the largest single exchange with just under 4,000 listed companies. NASDAQ and the Canadian TMX Group (which runs the Toronto Stock Exchange) are the two other global exchanges with over 3,000 listings, most other exchanges being considerably smaller. The global stock market is spread across thousands of listings and dozens of stock exchanges, with 60 major independent exchanges worldwide.
Indices give clarity to traders, allowing them to make sense of the complex, divided landscape of global equity trading. Asides from ‘all share’ indices, most indices use a concentrated selection of stocks to recreate the performance of the overall market. This makes sense, because trading volume is highly concentrated in a few major companies, with liquidity and volume in small cap stocks greatly reduced.
Stock exchanges have different listing criteria – minimum requirements for a stock to trade on the exchange – and it is not uncommon for small or illiquid stocks to be removed or ‘delisted’ from a major exchange. Each index also has its own criteria. For example, the 100 largest companies listed on the London Stock Exchange form the FTSE100. As the share price and market capitalisation of a stock fluctuates, this list will change, and indices are regularly recalculated to make sure all component stocks meet the listing criteria.
You cannot buy a stock index directly, because it is a measure of price performance rather than a financial asset. Instead, traders and investors buy index funds, or derivatives based on the index value. Index funds are mutual funds that recreate a stock index, normally by owning the same shares in the same proportion as the index they track. These are bought and sold from the provider like other mutual funds, and are settled outside of market hours. Exchange traded funds (ETFs) also allow traders to share the price action of an index, with the difference that they are listed directly on a stock exchange, and can be bought and sold intraday much like stocks. Finally, you can trade OTC derivatives based on the price of an underlying index. ADSS CFD traders use CFDs on major indices to speculate on global index markets.
Understanding what indices are, the types of index available, and what they measure is the first step. This allows you to identify indices you are interested in trading, and to start checking past performance and live market price action. However, before you trade indices in the UAE you can you need some practical basics.
Risk management when trading indices uses the same principles as other markets. Since an index fund measures the price of a basket of equities, index traders already benefit from a level of diversification. Even so, the different stocks that make up a national equity market or headline index for an exchange are normally closely correlated, and especially during recessions or market panics will sell off together.
It is possible to protect your portfolio by international diversification, for example holding Asian as well as American indices in the same portfolio. In some cases, this can protect against a regional equity market crash. In the largest sell-offs, however, international markets often move together, so index traders need to understand that you cannot entirely diversify an index portfolio with other stock indices. Instead, adding safe haven assets such as gold or reserve currencies like the US dollar can potentially help.
Index trading provides investors with a powerful way to gain diversified exposure to global stock markets. You can access this index market in multiple ways, using instruments like index CFDs, ETFs, and passive mutual funds. Whether trading major indices like the S&P500 and the FTSE, or regional market indices such as the Abu Dhabi Stock Exchange, traders can share in broad market movements without purchasing individual stocks. While indices trading offers built-in diversification through exposure to multiple companies, you should remember that markets can still move in tandem during global events, especially during risk off market rotations. Success in index trading indices requires a thorough understanding of technical and fundamental analysis, as well as mastery of risk management strategies. Major indices, such as the S&P500 or GER / DAX 40, each have their own characteristics and weighting methodology, so it is essential for traders to understand their chosen market before committing any of their capital.
What’s the difference between indices trading and investing in index funds?
Indices trading uses derivatives like CFDs, while investing in index funds involves buying and holding passive mutual funds or ETFs. While both provide exposure to market indices, indices trading through CFDs allows for leveraged positions and the ability to profit from both rising and falling markets with shorter timeframes. In contrast, index funds are typically longer-term investments that directly hold the underlying stocks and are better suited for buy-and-hold strategies.
How do stock indices like the FTSE and Dow Jones represent market performance?
Stock indices measure market performance through different methodologies – some like the Dow Jones use price weighting, while others like the FTSE use market capitalisation. These different approaches can lead to varying representations of market performance, and it is important to understand how your chosen index is calculated before trading.
What makes regional indices like the Abu Dhabi Stock Exchange unique?
Regional indices such as those on the Abu Dhabi Stock Exchange (FTSE ADX) provide focused exposure to specific geographic markets. They often include companies that might not be available in major global indices, offering investors focused opportunities to participate in regional economic growth and development.