Offering lower risk than individual stocks, alongside a more diverse portfolio with smoother price movements, stock market indices around the world are powerful indicators for both global and country-specific economies. Read on to learn more about some of the most popular indices trading strategies. So, what is the best trading strategy when trading indices? The answer is that there is no definite answer to that question. The best strategy is simply the one that best fits your availability, style and personality. Therefore, each trader needs to have a trading routine to find the perfect trading strategy that works for them.
Whether day trading, utilising a breakout strategy or applying technical indicators, always remember- using specific trade entries and reliable risk management methods will help you on your way to more beneficial indices trading. Your end of day profits will depend hugely on the strategies you employ.
Day Trading Indices
As the name implies, day trading is simply a method of buying and selling indices within the same day. The main principle of day trading is to close all open positions before the market closes. The advantage? To avoid any added costs or risks often associated with holding a position overnight. With day trading, your goal is to reap quick, yet modest profits from even the smallest price movements. But take notice- this rule makes day trading suitable for traders that have the time to pay constant attention to the markets. Unsurprisingly, the main disadvantage is that day trading is extremely time-consuming. Traders need to monitor the markets and be ready to make quick decisions if and when a price moves in a certain direction. Price changes typically result from economic or geopolitical news, so staying on top of current events can help you better understand why a price has moved, and even to anticipate the short-term trend, allowing you to make more informed decisions when buying or selling an index.
Corporate Financial Announcements
Due to the influence some large individual stocks have on an index, the prices of indices can be particularly volatile around earnings reports and key announcements, especially if the figures beat or fall behind expectations. Let’s take the Dow Jones for example: Apple is the second-biggest component of the Dow Jones Index and has significant influence on the index’s performance. If an announcement by Apple outperforms market expectations, not only can we expect the company’s stock price to rise, but also the Dow Jones in its entirety. The same goes for a disappointing announcement. Here, the company’s price would be likely to fall, and with it pulling down the Dow Jones.
Breakout Strategy for Indices Trading
Breakout trading is used by active index investors to take a position within a trend’s early stages. Generally speaking, this strategy can be the starting point for major price moves, expansions in volatility, and when managed properly, can offer limited downside risk. A breakout is a price moving outside a defined support or resistance level with increased volume. A support level is where a share price has shown a tendency to bounce back after falling and the resistance level is where the price has shown a tendency to rebound towards the downside after the price has risen. Here, a breakout trader will enter a long position on an index after the price breaks above resistance or enters a short position after the price breaks below support. Once the price moves beyond one of these barriers, the index will incline to be more volatile, and prices usually trend in the breakout’s direction.
Technical Indicators in Indices Trading
Technical index trading involves reviewing charts and making decisions based on patterns and indicators. These patterns are particular shapes that candlesticks form on a chart, and they can give you information about where the price is likely to go next.
There are 4 major types of indicators:
- Trend indicators show you which direction the market is moving in. They’re sometimes called oscillators because they tend to move between high and low values like a wave. Some of the trend indicators include Parabolic SAR, Simple Moving Average, Exponential Moving Average, Fibonacci Retracement, The Bollinger Bands and Moving Average Convergence Divergence (MACD).
- Momentum indicators show you how strong the trend is and can also tell you if a potential short-term reversal is going to occur. Waning momentum suggests that the market is becoming exhausted and may be due for a retracement or reversal. An accelerating momentum condition suggests that the trend is strong and likely to continue. The three primary trading signals that can be generated with the momentum indicator include the 100 Line Cross, the Momentum Crossover, and the Divergence signal.
- Volume indicators show you the volume of trading in a certain index and its change over time. This is beneficial because when the price changes, volume levels can give an indication of how strong the next move may be. Bullish moves on high volume are more likely to be maintained than those on low volume. This class includes On-Balance-Volume, Chaikin Money Flow, Acceleration Bands, Market Facilitation Index and Klinger Volume Oscillator.
- Volatility indicators show you how much the price is changing over a given period. As we all know, volatility is a fundamental factor in the market, and without it, there would be no profits. The higher the volatility, the more rapid the index’s price is changing, meaning more opportunity to capitalise. But remember- volatility tells you nothing about future direction, just the range of prices.
Position Trading Indices
Position trading generally involves buying and holding an index for a longer period of time. This can be for several days, weeks, or even longer. As a result, a position trader is less concerned with short-term market fluctuations. Position traders will make far fewer trades than day traders, with each trade carrying a greater potential for profit. However, holding a position for a long time can also increase the inherent risk. Position traders might take a position in an index before or even after a critical event, such as an NFP report or earnings season.
Trend Trading Indices
Similar to day trading, trend traders attempt to profit from short to medium-term market trends that influence the index. Here, traders only need to take a bullish or bearish position, depending on wider, overall market sentiment. When trading the trend, keep your position open as long as the trend continues. Apply stop losses and guaranteed stops to protect profits or reduce losses in the event the trend reverses.