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Trade Indices like a Pro |
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25th Aug 2020

How to Trade Indices like a Pro?

There is always a good chance that economists and analysts are talking about stock indices, when they refer to the “global financial markets.” These indices represent the price performance of a group of equities from an exchange, and they can reflect the overall state of a particular segment of an economy. Indices are an asset class, just like forex and cryptocurrency, that traders use to diversify their portfolio. Yet, something sets indices apart from other assets.

Not only do indices provide diversified exposure to a particular country or industry, historically, they have shown an innate trend of their own. This trend has been bullish for many stock indices. For instance, the S&P 500 that benchmarks the US stock market’s performance has generated a historic annualized average return of approximately 10%-11%, from its inception to 2019. The annual total return of the FTSE 100 has averaged 7.8% from 1984 to 2019. Bearish market moves have been typically shorter.

With a good amount of volatility and liquidity, trading indices can be a rewarding experience, just like leveraged forex trading, especially with the help of a forex broker who offers the lowest spreads. Here are some factors to remember when trading indices.
Unlike forex and cryptocurrency, where the number of buyers and sellers determine prices, index prices move based on the price movement of equities that are represented in it. These companies could be from one particular sector, like the Nasdaq 100, which represents technology companies, or the DAX 30, which tracks the top 30 companies on the German stock exchange.

Big changes in equity performance in a particular sector can impact index prices, especially if that sector occupies a large portion in the index. Also, it is important to consider market correlations. For instance, forex market movements can impact the domestic stock markets, and subsequently an index.

So, it is important to keep track of economic data and news releases that cause intense buying or selling pressure in the chosen index. For instance, the US Non-Farm Payroll report and US Federal Reserve announcements can cause major volatility in many US indices, including the S&P 500, DJIA and Nasdaq 100. The Euro Area GDP figures and inflation data can impact the DAX 30 and Euro Stoxx 600.
Trading with the trend can be an effective way to trade indices, using technical analysis tools and long-term charts. Some common trend indicators used are Fibonacci retracement levels, Bollinger Bands, Moving Average Convergence Divergence (MACD) and Parabolic SAR levels. Momentum indicators, like the 100 Line Cross, can show how strong the trend is and whether there are chances of a short-term trend reversal in the near future.

Traders attempt to increase the success of their trades by looking for ‘buy’ signals that are in line with the current market trend. For an upward trending market this could be buying at the support level and selling at the resistance level in downward trending markets.  The Relative Strength Index (RSI) can help ascertain whether the overall market is on an upward or downward trend. When RSI falls below 30, it indicates that the market is oversold, while when it breaches 70, it indicates a larger downtrend.

Positions are kept open as long as the trend continues. Stop losses and guaranteed stops need to be applied to protect against downside risks, in case the trend reverses.

It’s important to determine a stop-loss or take-profit level before entering a trade and to limit risk exposure to less than 5% for all trades.
While the release of high impact economic data can cause sharp volatility in indices, some indices are inherently volatile in nature. This is an important factor to consider when choosing an index to trade. For instance, the tech sector is usually volatile in the equity markets. Due to its high concentration on the tech sector, with big and riskier high growth companies listed on it, the Nasdaq 100 is the most volatile among all the US stock indices. The DAX 30 is also considered more volatile than the UK or US stock markets.

While volatility provides many trading opportunities, it also increases risk, which makes risk management strategies highly important while trading indices. It’s also vital to know the opening hours of the main market in the country, which is when volatility surges and traders can access tighter spreads.

Just like forex and cryptocurrency, experienced indices traders have a definite strategy, with predetermined entry and exit levels, position sizes and stop-loss levels. Having a defined trading strategy can help keep emotions at bay and encourage traits like patience and discipline in trading, the essential character traits of an experienced trader.