Stocks indicate the financial climate for individual companies, while indices allow traders to step back and look at the bigger picture of what’s going on in the financial markets. However, the nature of an index is such that traders have to take multiple stocks into account rather than a single company, which means that there are likely to be a larger number of aspects which are worth to be considered.
In the context of trading, Indices work in a similar way as many other Spread Bet and CFD products. Like individual stocks, which they are comprised of, traders can take positions based on whether they consider that the value of the index will go up or down. Again, as with individual stocks the aim is to either ‘sell’ at a higher price than the one it was ‘bought’ at or alternatively to ‘buy back’ at a lower price than the one originally ‘sold’. All the stocks listed on the index will be included in the ongoing calculations to determine the current level of the index, with the index rising or falling in value depending on the current strength or weakness of its component stocks.
Indices comprise of a number of different stocks, and thus the volatility of an index can be quite high, due to constantly changing share prices. This is also why indices move by more than a couple of percentage points on a daily basis, as it’s unusual that all stocks on an index would experience sharp movements in the same direction at the same time. There are occasions, though, when suck things happen; e.g. the stock market crashes in the 20th and 21st centuries.
In the following scenario, trader x decides to take a position on the FTSE100. Let’s say that the FTSE is currently trading at a level of 6949:6950, meaning that the spread is currently one point. The trader decides to ‘buy’ £10 worth of the FTSE at the 6950 level. Since the ‘sell’ level is 6949, the trader starts off £10 down, because if the trader were to close this position immediately that’s the loss they would make. Let’s say that the index subsequently moves up to a level of 6955:6956. If the trader were to sell his £10 worth of FTSE at this point, the profit on the trade would be £50; the first point of movement in the trader’s favour would turn their -£10 position into a £0 position (where they would be making neither a profit or a loss and would break even if they exited at this point), with the following five points of movement then being pure profit. However, let’s say that instead of the FTSE’s value rising, it instead falls to a level of 6945:6946. In this case, the trader would lose £50 if they sold at this point, because the price at which that £10 worth of FTSE is being sold is five points lower than the price at which it was purchased at.