The History of Index Trading
The first indices were published by financial journalists. The Dow Jones indices were calculated in the late 19th century by Charles Dow, who became the editor of The Wall Street Journal newspaper, which launched in 1889, and statistician Edward Jones.
The DJIA is the world’s second-oldest index, as it followed the creation of the Dow Jones Transportation Average, also known as Dow Jones Transports, in 1884. The transportation index calculated the average change in stock prices for the 11 largest transportation companies, of which nine were railroads. The indices were first published in the Customers’ Afternoon Letters, a two-page daily financial news publication.
The stock market boom that preceded the 1929 crash increased interest in stock market indices. The Standard Statistics Company, the predecessor to Standard & Poor’s (S&P), published its first stock index in 1923. And the New York Times and New York Herald Tribune began publishing indices during the 1920s.
The bull market recovery from the crash during the 1930s saw the launch of more indices, such as the Financial News Ordinary Index in 1935, launched by the forerunner of the Financial Times, which subsequently became known as the FT 30.
The first index fund for investors launched in the 1970s, and the first US ETF launched in 1993 – Standard &Poor’s Depositary Receipts (SPDR) S&P 500 ETF. Investor interest in trading baskets of stocks grew after the 1987 stock market crash and the technology boom, which began in the 1990s.
The explosion in the popularity of ETFs since the 2008 financial crisis has driven interest in stock market indices, as more investors have been drawn to passive investment strategies. Indices are predominantly used for benchmarking ETF portfolio returns, according to the Index Industry Association.
What is index trading?
Index trading is defined as the buying and selling of a specific stock market index. Investors will speculate on the price of an index rising or falling which then determines whether they will be buying or selling. Since an index represents the performance of a group of stocks, you will not be buying any actual underlying stock, but rather buying the average performance of the group of stocks. When the price of shares for the companies within an index go up, the value of the index increases. If the price instead falls, the value of the index will drop.
When you trade indices online, there are two main types: index cash CFDs and index futures CFDs. The main difference between the ‘cash’ market and ‘futures’ market is that the ‘cash’ does not have an expiry date. The ‘futures’ market, however, has an expiry date, normally known as a ‘rollover’. A futures contract is effectively an agreement between the buyer and the seller on the price that has to be paid by the buyer at a given future date.
Indices are traded as CFDs (Contract For Difference). This means you don’t take ownership of any asset, but simply trade the price movements. For example, if you are the buyer, you agree to pay the seller the difference between the current value of the asset and the value when the contract expires.
Index Cash CFDs
Featuring tighter spreads based on spot pricing, cash indices are generally considered short-term investments. Cash CFD traders tend to avoid holding positions overnight in order to avoid paying overnight trade charges, and will reopen trades the next day.
Index Futures CFDs
With a contract based on a price for future delivery, Index Futures CFD trades are generally preferred by traders interested in medium to long-term investments. This is due to the fact that this type of trade does not incur overnight funding or swap charges.
Trading Index Futures
A futures contract is a commitment to buy a specific asset on a predetermined date for a predetermined price. CFDs allow individuals to place Buy and Sell orders depending on whether they believe that an index will gain or lose in value.
In order to execute an index CFD trade, a trader must consider their position.
- Buy – Executing a ‘Buy’ order means that you believe the instrument will increase in value. If the price of the instrument does indeed climb and you close your position, your profit is the difference between your ‘buy’ price and the closing price. On the other hand, if you close your position at a price that is lower than your ‘buy’ price, then your loss is the difference between your ‘buy’ and close price.
- Sell – Executing a ‘Sell’ order means that you believe the instrument will decrease in value. If the price of the instrument does indeed drop and you close your position, your profit is the difference between your ‘sell’ price and the closing price. On the other hand, if you close your position at a price that is higher than your ‘sell’ price, then your loss is the difference between your ‘sell’ and close price.
How Does an Index CFD Trade Work?
CFDs allow you to trade on indices without purchasing the underlying asset. This quick way of gaining exposure to the underlying asset is just one of the benefits of CFD trading on indices. These CFDs save time, in comparison to traditional markets, by allowing for instant trading during trading hours and the option to increase purchasing power using leverage. This leverage can increase potential gains but also increases trader’s exposure to potential losses.