Indices are weighted measurements of the performance of the national stock exchanges of the world. Index assets are not as popular as other assets traded in the financial markets. In the scheme of things, index assets are rather few and some of the indices command more attention in the market than others.
The most common indices are:
- – Dow (US30)
- – Nasdaq (US100)
- – S&P500 (US500)
- – Xetra DAX (GER30)
- – Nikkei 255 (JPN225)
- – Hang Seng Index (HSI50)
- – Shanghai Stock Exchange (SSE180)
- – IBEX-35 (SPA35)
- – Zurich SMI (SUI)
- – Australian Stock Exchange (ASX200)
- – London Stock Exchange (FTSE100)
CFD indices are traded on a leveraged basis. These factors have implications on how traders can trade CFDs on stocks. The following is a description of the issues involved as well as how typical CFD stock trades are carried out.
Fundamentals of Stock Price Movements
Indices track the movements of their underlying stock exchanges. Therefore, index CFDs can only be traded during the hours that the underlying exchange is open for business. An exception is if the CFDs are based on futures contracts.
The majority of fundamental influences on index CFDs stem from systemic occurrences that move the majority of stocks listed on the underlying exchange. Factors that could affect an exchange to the extent of moving it in one direction or another include:
- a. Elections
- b. Policy statements on the economy, employment, imports or exports.
- c. Natural disasters
- d. Terrorist attacks or outbreak of war. (The Dow tanked nearly 1,500 points in the first trading day after the 9/11 attacks).
Technical Basis for Index CFD Trading
The same principles used in the technical trading of other assets are also used in trading index CFDs. Information that can be used for chart analysis of index CFDs include:
- – The trend of the index
- – Support and resistance levels
- – Price patterns
- – Candlestick patterns
- – Information from indicators
It is important to know the business hours of the indices you want to trade as CFDs. This will enable you to trade only when opportunities exist. Index CFDs tend to trend for some time. Therefore, the best bet is to trade within the context of a trend. Look to buy on dips (in an uptrend) or to sell in rallies (in a downtrend).
There are interesting pieces of news that could impact the overall direction of a stock market, and hence the index CFD that tracks the movement of that exchange. Political news tends to belong to this category, as policy pronouncements from governments have far-reaching consequences for an entire economy. An example of this is the positive effect that the various quantitative easing programs of the last 8 years in different countries have had on their local exchanges.
Indices tend to trend, which makes it relatively easy to pick out opportunities to trade on the medium to long-term, with the potential for huge profits. Here are two ways of using technical analysis to trade index CFDs.
Case Study: Dow30
Since the election of Donald Trump and the direction of his administration to churn out business-friendly policies, the US exchanges (Dow included) have been making new highs and setting new records. The medium-term trend for the Dow30 has been upwards, with occasional dips in between.
Trigger: long trade.
A technical entry that supports this upside bias is sought on the charts. This comes in the form of a symmetrical triangle. Triangles are basically continuation chart patterns. However, a symmetrical triangle presents a challenge because it does not produce a specific directional bias. The trader must, therefore, wait for the price to break out from one side before taking a position.
The Stop Loss (SL) is set below the lower trend line which borders the triangle and the TP can be set where a historical resistance has occurred, as this is a likely spot for upside price movements to stall. Reward-risk ratio (TP:SL) should ideally be a minimum of 3:1 or higher for best results.
Case Study 2: FTSE100
Chart patterns are not the only technical triggers for trading index CFDs. A very good way to buy on dips is to use the Fibonacci retracement tool to predict the extent of dip that would occur before a renewed rally. This is illustrated in the snapshot below:
The advantage of using the Fibonacci levels is that it is possible to use levels above and below price entry points as areas of possible support or resistance, depending on where the price of the index CFD is heading to.
Just like before, aim for a TP:SL ratio of at least 3:1. This is achievable with long-term chart setups.