If your aim is to become a successful trader, it is important to understand (and implement your understanding of) key financial concepts when choosing your
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Indices Trading FAQ
What are Stocks & Shares
Before we can look at the specifics of indices or averages, we first need to explore the underlying financial market assets that are included in stock indices: namely stocks, shares, or equities.
Shares are a type of security defined as part ownership in a company, usually, one that is publicly listed. This gives the owner of the share an entitlement to the corporation’s earnings and assets, voting rights in major decisions about the company at the Annual General Meeting (AGM), and a dividend payment if there is one (effectively a proportion of the company’s profits).
Furthermore, if the company is run profitably and successfully, the hope is that the company’s share price will rise, and the owner of the share will make a capital gain on the value of their shareholding. Stocks and shares are primarily bought and sold on Stock Exchanges.
What are stock or share indices (or averages)?
Averages are calculated from the prices of the selected stocks within an index (as we see below) and are used by investors as a way of gauging the performance of the different markets that the stock indices reflect. There are two main ways of calculating the value of stock indices: a price-weighted index or a capitalisation-weighted index.
Without doing a deep dive into the mathematics behind these calculations, in simple terms they differ in this way:
- A price-weighted index uses the price of the individual stocks to determine the weighting of the stock to determine the index value.
- A capitalisation-weighted index uses the value of the company to determine the weighting of the stock in the average.
The Dow Jones Industrial Average is an example of a price-weighted index. The S&P 500 a capitalisation-weighted index.
What influences the level of indices?
Many factors can influence the level of a stock index, but the main factors are:
Data: This includes both macroeconomic and microeconomic data.
Macroeconomic data is the major data that reflect the health of an economy or region and would include employment, inflation and Gross Domestic Product (GDP).
Microeconomic data is corporate data, which would include the usually quarterly release of company profits and revenues during earnings season. These data releases impact on an individual stock, and if the market moves are significant and/ or if the individual share has a significant weighting in an equity average, then it can have an impact on the overall index/ average.
Central Banks: Central Banks in most major economies control monetary policy, through changes to the national interest rate. Depending on how interest rates are expected to rise or fall in the future, this can impact on the whole economy by slowing or encouraging growth. That can affect individual shares and, by extension, the stock indices they form a part of.
Geopolitics: This is a broad concept which includes political, environmental, geographic and social impacts on economies and financial markets. Examples of geopolitics include trade wars (US-China trade war, 2018-2020), large political events (US elections, Brexit) and geographic events (also described as “Acts of God”) such as the Fukushima Daiichi nuclear disaster in 2011.
Examples of major global indices
US – S&P 500, Dow Jones Industrial Average (DJIA), Nasdaq Composite and Nasdaq 100, Russell 2000.
Europe – FTSE 100 (UK), DAX (Germany), CAC 40 (France), EURO STOXX 50 (pan-European), FTSE MIB (Italy), IBEX 35 (Spain), SMI (Switzerland).
Asia/ Pacific – Nikkei 225 (Japan), S&P/ASX 200 (Australia), Shanghai Composite (China), Hang Seng (Hong Kong), KOSPI (South Korea), Nifty (India).
Glossary of terms
The rate at which you can sell the base currency, in our case it’s the Euro, and buy the quote currency, i.e the Japanese Yen.
Ask (or Offer)
The rate at which you can buy the base currency, in our case the British Pound, and sell the quoted currency, i.e. the Japanese Yen.
The difference between the Bid and the Ask prices.
The value of one currency expressed in terms of another. Its fluctuation depends on numerous factors including the supply and demand on the market and/or open market operations by a government or by a central bank.
Usually, the contract size is based on a lot system, and for most currency pairs 1 lot is 100,000 units of a base currency.
Minimum rate fluctuation
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