Trading stock indices is a popular activity among investors and traders worldwide. Stock indices differ from other financial markets, as they represent the economy of a country or a region, and tend to grow over time, despite occasional corrections. In this article, we will explore different trading strategies and styles that work when trading stock indices, as well as how to approach shorting and corrections.
Indices vs Other Markets
Stock indices have a distinct pattern of performance compared to other financial markets. While currencies and commodities tend to be range-bound, stock indices have a clear upward trajectory. This is because indices represent economies that grow over time, with occasional recessions. Over the last 30 years, major indices such as the FTSE 100, DJIA, DAX, and S&P 500 have posted positive annual returns the majority of the time.
Which Trading Styles Work on Indices?
Due to their regular returns, indices are popular among long-term position traders who use investments like exchange-traded funds to take a position on an entire index without buying each individual stock. Swing traders can use the ample oscillations that occur due to occasional corrections in the market to drive medium-term profits. A typical swing trade on an index involves waiting for a small retracement after a breakout, then buying before the bull move resumes.
Bollinger bands can also be used to identify buy opportunities. If an index drops below the lower band into oversold territory, it may be about to bounce back, providing a buy opportunity. Short-term day traders and scalpers often focus on indices, using contracts for difference (CFDs) to take advantage of high volatility offered by the world’s top indices.
Shorting and Corrections
Stock market crashes and index corrections offer traders the chance of a ‘big short’ for big profits. However, predicting the timing of a crash is extremely difficult. Markets can run at irrationally high levels for a long time, and analysts may predict a correction months or even years before it actually arrives.
When a bear run does occur, traders can use a short position to gain profits. However, traders need to ensure that their losses don’t put them on margin call, forcing them to close their position before seeing any profit. Traders use tools such as the Volatility Index (VIX), which uses options prices to measure the market’s current fear level. A high VIX reading indicates that sellers might be about to take over. Skyrocketing price-to-earnings (P/E) levels are also seen as an indication of a market bubble that is likely to pop soon.
In conclusion, stock indices represent a popular trading instrument for investors and traders alike. Understanding the market’s tendencies and patterns can help traders make informed decisions and achieve their trading objectives. By utilizing different trading styles and strategies, traders can capitalize on market movements and create profitable opportunities.
