Over the last several years, indices have become much more popular with retail traders. This is because an index is a group of stocks instead of a single stock, eliminating a lot of the extra noise from a particular company. The idea is that if the overall group of stocks is going to make a move, then you can profit from getting the overall direction of the market correct.
Indices trading gives you the ability to either buy or sell the index without going through the process of picking a particular stock nor do you have to borrow a particular stock as indices can simply be sold directly. Should you believe that the market is going to fall, you simply bet on the entirety of the market.
Short-term technical trading
Most traders will be of the short-term variety when it comes to trading indices, so by extension, this is an asset that tends to be very technically driven. The most common approach to trade in the index is what is known as “top-down trading” when you look at higher time frames to see the trend and then execute on shorter time frames that agree with the overall trend.
This does not mean that you simply buy an index if it is in an uptrend, rather you look for technical indicators to confirm price action. Looking for support on a pullback is one of the most common ways, but other traders might use something along the lines of a moving average to confirm that the market is in fact starting to move in the same direction as well.
Another strategy that a lot of traders will put into practice is a breakout strategy. This is when a market breaks out of an obvious consolidation area. For example, if the DAX breaks out of a rectangle pattern that it has been in for the last several hours, the trade will simply follow that breakout and look for the next target.
Swing trading
One of the great things about trading and index is that you can also do what is known as “swing trading.” Swing trading is when you are trying to catch major highs and lows and tend to hang onto a trade for much longer. Indices do tend to trend for long periods of time, so therefore your gains can compound over the longer term.
When you look at the structure of most indices, they tend to favor the upside, and in fact, are designed to rise over the longer term. This is because they are not equally weighted, as the markets are made up of varying sizes of companies.
Know the leaders
One of the most important things you can do when you are trading in an index is to understand who the leaders of the index are. For example, the NASDAQ 100 has a handful of stocks that make up a majority of the calculation, and they are all of the stocks that you would expect: Apple, Alphabet, Microsoft,Tesla, and a handful of others. Make sure that before you trade in an index you understand the most important handful of stocks to pay attention to. If those stocks all move higher, then odds are the index itself will have to follow.
Conclusions
Index trading is a great way to make a bet on the entirety of the market and can simplify the process of trading or investing. The index is made up of a group of stocks based upon some type of criteria, so it is important to understand what the criteria are.
Looking at the leaders is without a doubt one of the most important things you can do because indices are very rarely equal-weighted. In other words, pay attention to the biggest volume stocks, they will lead the way.
You should also pay close attention to technical analysis, which these indices do tend to follow quite well. This is especially true if you are trying to trade shorter-term time frames.
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