What are Equity Indices and How do You Trade Them?

What are Equity Indices and How do You Trade Them?

Written on

Jul, 2018

Updated on

Aug, 2020

Table of content

Equity indices are baskets of stocks that are traded together. The most liquid equity indices are stock indices that cover some of the most actively traded stocks in the world. In the U.S, the Dow Industrials, the S&P 500 index and the Nasdaq 100 are the most popular equity indices. In Europe, the German DAX the FTSE 100 and the French CAC are the most liquid. In Asia, the Nikkei and the Shanghai along with the Australian All Ordinary are the most robust indices.

Why Does the Price of Equity Indices Fluctuate?

Equity indices gyrate daily due to several factors. Macro events, political uncertainty, changes in monetary policy as well as earnings drive changes in equity indices. The broadest equity indices such as the Dow Industrials and the S&P 500 fluctuate with macro events that describe the strength of the U.S. economy. They additionally move higher when interest rates are at relatively low levels. When the economy gets too strong and the Fed begins to rachet up interest rates, future discounted cash flows begin to decline eroding the value of equity indices.

Earnings Season Can Be Volatile

Earnings are also a large mover of indices especially for stocks that are major components of those indices. For example, the Dow Industrials is a market cap weighed index which means that the largest stocks hold the most weight. Since Apple is the largest component of the Dow Industrials, large movements in these shares will alter the value of the Dow. Therefore, you can trade the Dow around Apple’s earnings release along with the share price.

The Nasdaq is a technology-oriented index. Earnings releases for some of its largest components can also move the market. Large technology stocks that compose the Nasdaq 100 include, Amazon, Google and Microsoft. The heart of earnings season which is usually within the first 4-weeks of the end of a calendar quote is an exciting and volatile time for market participants. Many FX brokers offer investors an opportunity to trade a plethora of indices during earnings season.

In addition, other brokers offers contracts for differences on sector ETFs. This way, you can trade a sector that is outperforming following an impetus. For example, strong U.S. manufacturing numbers will be beneficial to manufacturing and mining ETFs. A robust earnings report from a technology giant will drive the price of the technology ETFs.

Sector ETFs also give you the opportunity to trade indices as pairs. If you are looking for a market neutral trade, you can buy one index and sell another against it. If you believe that the Dow will outperform the Nasdaq, and do not want exposure to the outright movements of these indices, you can place a pair trade. A pair trade speculates on performance as opposed to the direction of a security. Many times, you might consider purchasing one sector ETF and selling another. Pair trades can be executed on the trading platform and is an excellent strategy to add to your trading arsenal.

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