There are a lot of benefits of trading indices, probably even more than you could think of. Should you consider it?
While most people prefer more straightforward assets like forex or cryptocurrencies, others might prefer something unique like indices. Indices are a statistical measure of change in a sectoral or a market-wide index.
It has first become popular with the Dow Jones Industrial Average (DJIA) which was created by Charles Dow in 1896. Over the years, DJIA is not the only asset you can trade in the indices market since you can also trade bonds and commodities as well.
Now the real question is, what are the benefits of trading indices?
- Hedging: The ability to offset the risk by opening trades in the opposite direction.
- Diversification: Moderate your risk by dividing your trades into several types of assets, in which indices can be one of them.
- Low cost: There's no active fee management, you only need to pay commission to the broker.
- Less liquidity risk: Indices are traded in an active market so you don't have to worry about pending executions of your trades.
- Convenience: Trade different stocks all at once just by choosing one indice.
To elaborate on each point above, let's get to explore the explanation below.
Hedging is a strategy that a trader applies to limit the risk in financial assets. A lot of traders do this by taking opposite positions that correspond to their existing positions. But how do you do it with indices?
For example, you are expecting the market to go up by 10% after a huge news release. But at the same time, you also speculate that the price might fall first before they finally recover in the next couple of months. Now what you can do is hold your portfolio and hedge your risk by selling indices.
The scenario is that when the market goes down, you book profits on indices of your choice. This will hopefully reduce the average cost of holding your main positions.
2. Diversify Your Portfolio
Portfolio diversification is another method to protect your assets from unpredictable movement in the market. This method involved opening positions across multiple instruments.
The best way to do it is to look for asset classes that have negative correlations. So when one asset moves down, the other would counteract it.
Trading indices is one way to do it. It can help you structurally diversify your portfolio and minimize the risk that might occur in the market. Diversifying your assets using indices can also help you reduce the exposure of your portfolio to volatility.
3. Low Cost
Another benefit of trading indices is that they have considerably lower costs compared to other instruments.
The commission rate on this instrument is much lower. In fact, most brokers will offer you fixed brokerage packages on indices and that makes it more affordable.
Another reason why trading indices have low fees is that there is no active management. This can help you save more money while at the same time helping you to generate more profits.
4. Less Liquidity Risk
While other instruments have issues regarding liquidity, the same thing is less likely to happen with indices. This is why a lot of institutional traders preferred indices compare to other financial products. Since the liquidity risk is relatively low, the spreads are also tight.
At the same time, this makes indices fairly safe because you tend to get stuck in the market due to less liquidity. In fact, this has been one of the main reasons why a lot of professional traders suggest trading indices.
Trading indices also mean you get access to a lot of instruments at once. For example, the S&P 500 is a stock market index tracking the performance of 500 large companies listed on the US stock exchanges. This would be incredibly hard to replicate at an individual level, making it very convenient to trade with.
See also: List of Forex Brokers to trade Stocks
How to Start Trading Indices
Now that you understand all the benefits, you might want to try trading indices by yourself. If you don't know where to start, here is how you can do it.
- Choose The Right Indices
It is highly suggested that you spend some time researching the instruments beforehand, how they behave, and which broker offers them. One of the most common indices to trade with is the S&P 500 which is composed of 500 large US companies, and the Dow Jones Industrial Average (DJIA), a composite of 30 US large-cap companies. If you expect a particular region or sector, you can also choose to trade indices that specialized in such areas like the Shanghai SE Composite Index (China) or the Nikkei 225 (Japan).
- Find a Good Broker
Not all brokerages provide indices trading. Brokers like IC Markets can be a great choice for this. This broker offers 25 indices to trade with leverages up to 1:200. You can also get tight spreads as low as 0.4 pips with deep liquidity and no commissions.
- Trade Diligently
Once you decide which indices you want to trade with and which broker to do this with, it's time to actually buy the instrument. To do so, you must open a live account with the broker of your choice.
A lot of people might argue that trading indices can be risky. However, it also has several advantages. It is a great way to hedge your positions and diversify your portfolio. Indices also have considerably lower costs compared to other financial products.
With that being said, it's always important to try indices in a demo account before you put any real money into your trades. Such a broker that could provide a good demo account for indices trading is IC Markets. Further information about the broker can be found below:
IC Markets is an online forex broker operating under the company of International Capital Markets Pty Ltd. Traders under the Australian jurisdiction are provided with the trading service of IC Markets AU that is headquartered in Australia and licensed by the Australian Securities and Investments Commission (ASIC).
On the other hand, non-Australian traders who open an account in this broker are registered under IC Markets SEY that is based in Seychelles, and regulated under the Seychelles Financial Services Authority (SFSA). The dual operation is a result of the relatively new rules from ASIC that prohibit their regulated broker to offer trading services outside Australia.
Classified as an ECN broker, IC Markets provide clients with MetaTrader 4, MetaTrader 5, cTrader as platform trading options. This broker also follows market trends to include Cryptocurrencies as one of its products, enriching its already wide selection of trading assets that include Currencies, Indices, Metals, Energies, Softs, Stocks, as well as Bonds.
The minimum deposit in IC Markets is in the middle range compared to other ASIC-regulated brokers, as it reaches $200 for every client. Market analysis materials are also prepared regularly for trading insights on IC Markets's official website, proving their competence to serve their traders with important contents created by market experts that work specifically for them.
For payment methods, IC Markets allows funding and withdrawal via wire transfer, credit card, PayPal, Skrill, Neteller, FasaPay, UnionPay, as well as Bitcoin via BitPay. The more interesting aspect from this broker is its multi-base currencies that include USD, AUD, EUR, GBP, SGD, NZD, JPY, CHF, HKD, and CAD.
As the trading technology in IC Markets is highly equipped with co-located servers and extremely low latency (especially on cTrader), the broker is widely known for its capability in hosting traders with the special needs for high-frequency trading as well as scalping.
To sum up, IC Markets is a fitting destination for active traders looking for a well-regulated broker. IC Markets is also flexible in terms of base currency and payment methods, signaling their commitment to welcome traders beyond their home country. As of late 2019, IC Markets provided their website in 18 international languages including English, Korean, Indonesian, French, Spanish, Italian, Malay, German, and Chinese.