What is an Index?
A stock index measures the price performance of a group of shares in a particular exchange. For example: The FTSE 100 represents the 100 largest stocks that are being traded on the London Stock Exchange. When the price of the stocks rises, the price of the index itself (the FTSE 100) goes up or vice versa.
There are thousands of Indices in the financial market, with some of the most widely followed indices being: The S&P 500, Dow Jones Industrial Average, DAX 30, Nasdaq Composite, FTSE 100. Indices can be constructed in a variety of different ways but are generally identified by capitalization and sector segregation.
Indices are commonly cited financial assets, and are often used to give a measure of approximation of the health of a stock market. They can also serve as a major indicator of the overall health of an economy and can help in analysing a market’s trends. There are indices for entire sectors and sub-sectors, groups of companies from any country, emerging markets etc.
What is Index Trading?
When trading indices, if there is a certain issue that would affect the companies listed on a certain index, you would buy or sell a CFD for that index depending on which way you believe the market will move.
For example: After research and speculation, you believe that an announcement about raising taxes for corporations in Germany will have a huge impact on a number of companies listed in the DAX 30 (a popular German index) and you believe that the DAX 30 will drop, you can choose to sell the CFD on that index and if you are correct, you will earn a profit from the price movement. However, if you are wrong, you would realise a loss.
Although varying by index, indices are periodically recalculated and rebalanced. This depends on the size and capitalization of the companies in the index. Higher performing large companies within an index, can outweigh poorer performance by some other companies in the index, and the price can decrease or increase accordingly. Indices have wide exposure to a number of underlying companies which can help with diversification.