Trading index CFDs

index CFDs

Trading index CFDs allows you to trade on the performance of stock markets or industries as a whole. Below, we'll discuss what indices are, what CFD trading is, the best brokers and how to get started in the stock market.

What is a stock index?

An index represents the performance of a market or a group of assets in a fixed and uniform manner. Indices can track specific stock markets, like the FTSE 100, or economic areas and industries, like major tech stocks, major auto stocks, etc. Indices can encompass an entire market, such as the TAIEX which tracks the movements of Taiwan's stock market as a whole. In finance, you can't invest directly in an index.

Indices have different methods of calculating their value and weighting their components. Typically, an index has a base value, for example 100, and a base year. The value then increases or decreases depending on the performance of the index's components. The change in an index's value is often more important than the value itself, as it indicates whether the market is expanding or not.

Traders' favourite indices

CFD index trading is increasingly popular amongst traders. Some of the most commonly traded indices are:

The FTSE 100

The FTSE 100 is the British stock index that tracks the performance of the shares of the top 100 companies listed on London's Stock Exchange (LSE). However, just because the index tracks stocks listed on the LSE doesn't mean that it only contains UK-based companies. This index is maintained by the FTSE Group, which is a subsidiary of the LSE Group. The FTSE 100 is one of the most popular CFD index trading instruments.

The NASDAQ 100

This US index represents the 100 largest non-financial companies listed on the NASDAQ stock exchange. The weighting of stocks in the index is based on their market capitalisation, with rules in place to limit the influence of the largest stocks. You can find an index composed only of financial companies in a separate index called NASDAQ Financial-100.

The Dow Jones

This US index includes the top 30 companies listed on the New York Stock Exchange (NYSE).

The S&P 500

This index features the 500 largest US companies (in terms of capitalisation). It is popular for index CFD trading as it tracks a significant portion of North America's economy.

The DAX 40

This German index tracks the performance of the top 40 companies listed on the Frankfurt Stock Exchange. Although it's not as big a market as the American ones, it is still popular for CFD index trading due to the market's sustained activity and price movements.

Why are indices ideal for CFD trading?

Index CFD (Contract for Difference) trading means you're speculating on some of the world's biggest companies. This allows for diversified exposure to the underlying market without having to invest in individual companies, which spreads your risk. This means that there is a reduction in the possibility of wild market movements in reaction to big news announcements (whether favourable or bad).

As a trader, you don't need to do in-depth technical analysis of individual companies when investing with index CFDs. Your investment will likely be spread across multiple industry sectors, reducing the stress of manually identifying potential stocks that are worth considering. Trading in stock indices is possible 24h/day and is not necessarily limited to regular stock trading hours.

Benefits of trading index CFDs

  • Your positions are naturally distributed across several sectors and companies, which diversifies your investment and reduces the possibility of radical instability.
  • Returns are measured based on the performance of the index as a whole and not on that of individual stocks, which means you benefit from the positive performance of any stock included in the index.
  • You can “short sell” an index if its overall performance is declining, allowing you to profit from bear markets.
  • Trading index CFDs allows you to speculate on different world markets, rather than individual stocks, which requires much less research.

The downside

  • You don't own any of the stocks included in an index on which you are opening a CFD trade.
  • Although the performance of the index you are trading is not heavily influenced by a single company and is more stable than trading individual stocks, the value of the index can still undergo drastic changes. There is always a chance that you will lose more than what you invested if you trade on margin, so you still need to be careful.
  • Trading index CFDs is not permitted in all countries. The US, for example, has banned all CFD trading!

Strategies

Follow the news

Before deciding which index you want to trade using CFDs, make sure you keep up with the latest financial news. Changes in local laws can have a huge effect on region-based indices and being able to spot where the market is likely to be heading will put you in a better position to make money. More importantly, it will allow you to stay aware of possible future moves, reducing the chances that the market will catch you off guard.

Hedging your positions

Since CFDs allow you to "short" an index, it can be used to hedge your other investments. If your portfolio is made up of multiple stocks of the same index and you expect the market to drop suddenly, you can sell the index short with CFDs to offset any losses you will incur with your primary investment, thereby reducing your exposure during an eventual market decline.

How to trade indices with CFDs

Choose a broker

To start trading indices, you must first find a CFD broker that offers the right instruments. When doing your research, it is useful to consider the following items:

  • Leverage Rates: If you want to trade a specific index, first investigate and compare the margin trading conditions that brokers offer. The lower the margin, the lower the initial investment needed.
  • Spreads: CFD brokers often earn money from the spreads they offer you. The smaller the spread, the less profit you need to make to cover the costs of trading.
  • Reputation: The reputation of a broker is important since some countries have limited regulations for this type of trading. Is the broker well known? Has it ever had problems with its platform?
  • Client support: The last thing you want is to not be able to access your funds or act on your trades due to platform issues. Client support shouldn't be overlooked, some brokers even offer 24/7 support.
  • Fees: There are many fees that can be associated with CFD trading, such as overnight holding fees (rollover - swap) and trading fees. Compare the costs of using each broker and keep them in mind in relation to your trading approach.

Many brokers offer CFD trading on either commercial or proprietary platforms. Picking the right broker can mean the difference between success and failure. A list of recommended CFD brokers is at the very bottom.

Opening a trade

As a general rule, you should never invest more than you're prepared to lose. Most index CFD trading platforms are easy to use, and entering and exiting a trade is quick and straightforward. You will have the option of buying (long) or selling (short) any index you want.

By going long on an index CFD, you make a profit when the value of the index increases, while by going short, you profit if it decreases. Most brokerage platforms provide you with detailed information about different instruments, presenting their historical data to help you make your decisions.

Tracking your position

You should closely monitor your positions once you've opened them, implementing automated exit strategies where possible. If you think your position is going bad, you should exit it to avoid extra losses. Some platforms allow you to place automated limits (stop orders), which will exit your trade for you when reached.

However, the negative balance protection offered by some brokers is less a guarantee than a goal, as unfavourable trading conditions, often combined with high leverage, can still cause you to lose a lot of money. Rapid and volatile market changes can sometimes be too rapid for loss prevention strategies to be effective.

Index trading tips

Here are a few helpful tips that should help you become a successful stock index trader.

  • Use stop losses and take profits to limit your losses.
  • If you own a stake in shares of an index's companies, consider hedging during times of poor market performance to offset your losses.
  • Don't invest more than you can afford to lose.
  • Beware of using high leverage, because although profits are increased, losses are also amplified.

A final word

Trading index CFDs is a great way for you to access the index markets without the need to physically invest in funds and trackers, and to make money by correctly speculating on an index's price movements. Leveraged trading is offered by most CFD brokers and allows you to amplify profits and access markets with less capital, however losses are also amplified.

F.A.Q.

How do CFDs work?

Trading CFDs on stock indices allows you to speculate on the future performance of a market without needing to own the asset in question. CFDs are often more accessible than cash products and you can profit from both bullish and bearish markets.

What is a stock index?

An index measures a stock market, or a subset of the stock market, that helps traders compare current price levels with past prices to calculate market performance. It is computed from the prices of selected stocks (typically a weighted arithmetic mean).

What is a long or short CFD position?

When you buy "long" you predict that the value of the index will increase. When you sell "short", you expect the opposite, that its value will decrease. If your predictions are correct, you will make money.

Are trading hours the same for all index CFDs?

No. Index CFD trading hours vary from index to index. Some indices can be available 24 hours a day, while others track the business hours of the equity markets on which they are based.

The best brokers to trade indices

BrokersIndex CFDsLeverageDAX40 spreadCAC40 spread
36 1:20~ 1 pip~ 1.1 pip
11 1:20~ 1.62 pip~ 0.8 pip
33 1:20~ 1.5 pip~ 1 pip
27 1:20~ 0.8 pip~ 0.8 pip
CFD trading involves significant risk of loss, so it is not suitable for all traders (74-89% of all retail investor accounts lose money when trading CFDs).