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Indices Trading Strategies

An index is made up of a collection of individual stocks, which are grouped together. So when you trade an index, you’ll find that there are some differences to other forms of trading. Here are some factors to keep in mind.

  • 01

    Monitoring Index Sectors

    Indices can come in a variety of sizes, ranging from the DAX 30 in Germany to the gargantuan Wiltshire 5000 index.

    No matter how big or small the index, something to consider are the individual parts that it is made up of and whether a high percentage of the stocks are focused on a specific industry.

    Over 10% of the UK FTSE100 for example, is composed of energy and mining stocks. This means that any change in the value of a commodity and consequentially a price movement for commodity-related stocks could have an impact on the FTSE in its entirety. Examine the index you’re investing in to ensure that you’re not caught out by such developments and can instead attempt to capitalize on such opportunities.

  • 02

    Currencies and Indices

    A weak or strong currency can lead to a shift in index value, so it pays to be aware of Forex rates.

    So for example, 2014 saw the value of the USD soar against the JPY. Valued at 1:102 early in the year, by the end of the year it had moved to 1:120. In this period the Nikkei 225 grew by a significant margin, going from around a 14-15k level to nearly 18k.

    So how exactly can the fortunes of a nation’s currency affect its major index? In this example, a weakened JPY was positive news for Japan’s exporters, the biggest of which play a key role in the country’s economy. The more fragile Yen allowed exporters to sell their products abroad for a lower price than, whilst still retaining a similar profit margin in their own currency. With export-focused companies invigorated, revenue and profits were could be boosted, which in turn meant that stock levels rose and consequently drove up the Nikkei.

  • 03

    Changes to Indices

    The stocks that make up an index can change over time – the S&P 500 Index, for example, has very few companies listed now that were present when the Index was incorporated in its current form back in 1957. Company mergers can see two stocks becoming one, as was the case in 2014 when the UK companies Dixons and Carphone Warehouse merged, giving birth to Dixons Carphone.

    Bankruptcy is another factor that can result in a change to an index, with a firm’s stocks subsequently unavailable to be traded. Another issue can be the level of the company’s market cap. If it gets too small it might not be eligible to remain on a specific index. The FTSE 100, for instance, is made up of the UK’s 100 biggest publicly traded firms, so if a company’s value shrinks, it could be demoted and replaced by a company from the FTSE 250 which has a higher net worth.

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