Understanding Index Fluctuations
Now that we’ve explored the ways that indices are calculated, we can begin to understand their valuations and how they move up and down.
During larger market events such as natural disasters, international trade disputes, or the Coronavirus pandemic, shareholders become nervous that the value of their investments may go down. This nervousness is expressed through the selling of their shares. Some shareholders may be happy to sell, knowing that if they hold on to these investments for a long time, there is a chance that a company may go out of business and the value of their investments will dissipate. As the market becomes flooded with sellers, buyers might come in and pick up shares at a reduced price
On the other hand, new technology, trade agreements, positive earnings reports, or any other reason to feel optimistic in the market may lead investors to invest heavily in the company, raising the demand for a stock that is in a fixed supply.
As the value of a company grows, combined with the supply and demand of their share, it moves the share price as well.
When considering the value of an index, companies are continuously gaining and losing value on a daily basis, yet the average may balance out. This is why some top performers may lose value, yet if the value of other performers climbs up, the overall value of the index may remain the same.
Difference between index mutual funds and index CFDs
Traditionally, an investor would purchase a unit or share of an index mutual fund. These are compiled by traditional brokerage houses who purchase assets which are traded on the NYSE, NASDAQ, LSE, or others. At the end of each trading day, the fund’s assets are calculated and the value of each share is adjusted. Only at that time can a shareholder sell their share to the open market. The next day, at closing, buyers are allowed to purchase those released shares at that day’s new value. This makes trading mutual fund indices complicated because the trade is placed before the true value is calculated.
When trading CFDs, you are not purchasing the underlying asset. Rather, the trader is taking out a contract that is based on the movement of the index or instrument. What’s more, these are traded with leverage, meaning if a share is offered with a leverage of 1:10 and valued at 100 Euros, the initial payment to trade is only 10 Euros.
For example, if you choose to place a buy order and the value rises, your profit will be based on the full value of the trade regardless of the margin that was traded on. If the instrument loses value after the buy order, you will be responsible for the full loss regardless of the margin that was traded on.
ETF CFDs allow traders to open a contract to speculate on the price movement of these ETFs using leverage and without having to purchase the underlying asset.
Difference between Index ETFs and ETF CFDs
An Exchange Traded Fund (ETF) is a fund that may follow a full market index. For example, there is the SPDRUSA500, which follows the S&P, and the TQQQ which follows the NASDAQ 100. They are often passively managed, which means that while there is a designated fund manager, the manager only has access to a specific percentage (such as 5%) of the overall fund to invest on their own. The rest follows a whole-market index.
ETFs are often purchased and traded in a similar manner to stocks, so unlike mutual funds that are only traded at the end of each trading day, an ETF can be purchased throughout the day. Traders should be aware that unlike stocks, there is often a transaction fee and expense ratio attached to an ETF which affects its desirability to those who are looking to make short-term transactions.
ETF CFDs allow traders to open a contract to speculate on the price movement of these ETFs using leverage and without having to purchase the underlying asset.