1.0 INTRODUCTION

Experienced traders are keenly aware of the main U.S., European, and Asian stock indexes. Even inexperienced traders will have likely heard of the indexes that are reported in the news. 

Examples of closely watched indexes around the world include the S&P 500, Dow Jones Industrial Average, FTSE 100, Nikkei 225, CAC 40, DAX, SENSEX and NIFTY. The first index was created by Charles Dow in May 1896.

It has evolved into what we know today as the Dow Jones Industrial Average. Before deciding to trade indexes, it is important to understand the difference between index trading and stock trading.

While most traders recognize the index names, many new traders don’t know how the stock indexes are traded. They often assume that they are traded like individual stocks. However, stock indexes cannot be traded directly.

Instead, they exist for informational purposes only—as a way to track the performance of a group of stocks.

Market data is available for the stock indexes, and they can be charted like any other stock, but there is no way to make either a long or short trade on the actual stock indexes themselves.

That’s where other financial products come in, like futures and options contracts, which can be used to trade the movements of stock indexes. 

Index Trader trades with a group of stocks which make up the measurement of the value of a section of the stock market known as Index. It is calculated from the prices of selected stocks.

This whole process is called Index trading. Trading stock indices is normally more rewarding to an investor or a trader because in general indices have a higher return than the stock market they represent partially or wholly.

2.0 INDEX TRADING

An index is an indicator or measure of something, and in finance, it typically refers to a statistical measure of change in a securities market.

In the case of financial markets, stock, and bond market indices consist of a hypothetical portfolio of securities representing a particular market or a segment of it.

An index is a method to track the performance of some group of assets in a standardized way. Indexes typically measure the performance of a basket of securities intended to replicate a certain area of the market.

These may be broad-based to capture the entire market such as the Standard & Poor’s 500 (S&P 500) or Dow Jones Industrial Average (DJIA), or more specialized such as indexes that track a particular industry or segment.

Each index related to the stock and bond markets has its own calculation methodology. In most cases, the relative change of an index is more important than the actual numeric value representing the index.

“Indexing” is a form of passive fund management. Instead of a fund portfolio manager actively stock picking and market timing—that is, choosing securities to invest in and strategizing when to buy and sell them—the fund manager builds a portfolio whose holdings mirror the securities of a particular index.

The idea is that by mimicking the profile of the index—the stock market as a whole, or a broad segment of it—the fund will match its performance as well.

3.0 STOCK TRADING

A stock index is a sampling or collection of stocks that gives an overview of how a specific part of the stock market is performing. For example, a technology stock index will track technology stocks.

The index moves with the overall performance of the stocks that it holds within it. This index can then be used by investors who want to quickly gauge the performance of technology stocks, either at that moment or over time. 

Indexes are popular because they provide information for a basket of stocks, not just one. They make great analysis tools, which makes them great trading tools, as well.

They can’t be traded directly, but some products allow traders to participate in the movements of stock indexes.

The S&P 500 is a very popular index among individual and institutional traders because it provides access to 500 stocks with a single futures or options contract transaction.

4.0 CONCLUSION

Indexes are a popular trading vehicle, but they can’t be traded directly. An index is simply a collection of stocks (or other assets) that moves according to the stocks held within it.

Traders can analyze both the index and the futures/options contract they are looking to trade. Indexes don’t expire, but futures and options contracts do, so traders need to make sure they are trading the appropriate contract. 

Investing in an index can only be done indirectly, but index mutual funds and ETFs are now very liquid, cheap to own, and may come with zero commissions.

They are the perfect set-it-and-forget-it index option. Indexing on your own requires time and effort for researching and building the proper portfolio and can be costly to implement.

Derivatives trading utilizes specialized knowledge and often requires a margin account with futures and options trading approval, and will require you to roll positions as they expire.