1.1 What Are Indices?

In financial markets, indices (plural of index) are benchmarks used to measure the performance of a specific group of assets within a market. An index represents a hypothetical portfolio of securities—most commonly stocks—that are selected and weighted according to predefined rules.

For example:

• A Japanese stock market index tracks the performance of major companies listed in Japan.

• European stock market indices measure the performance of key companies across European markets.

Indices can be designed to track:

• A country or region (e.g. US, Europe, Asia)

• A market segment (large-cap, mid-cap, small-cap)

• A sector or industry (technology, healthcare, banking)

• A specific investment theme

Because indices summarise the performance of many securities into a single number, they offer investors and traders a powerful way to understand overall market movements at a glance.

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1.2 Why Are Indices Important in Financial Markets?

Indices play a critical role in helping investors interpret market conditions.

Take the S&P 500 Index as an example. It tracks 500 of the largest publicly listed companies in the United States across 11 major sectors. These companies include global giants such as Apple, Microsoft, Amazon, Tesla, Visa, and Johnson & Johnson.

Since these corporations collectively represent a significant portion of the US economy, the performance of the S&P 500 is widely viewed as a barometer of the overall health of the US stock market and economy. Over time, it has become the most commonly referenced benchmark for US equities.

Why Trade Indices?

An index itself cannot be traded directly because it is only a benchmark—not a financial instrument. However, indices form the foundation of several tradable products, such as:

• Index Exchange-Traded Funds (ETFs)

• Derivatives, including Contracts for Difference (CFDs) and options

For example, the Vanguard S&P 500 ETF (VOO) is designed to closely track the S&P 500. By trading or investing in VOO, investors aim to replicate the index’s performance.

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1.3 Advantages and Disadvantages of Trading Indices

Pros of Trading Indices

Convenience

Trading an index provides exposure to a broad set of companies without needing to analyse each stock individually. Index compositions are reviewed and updated regularly, ensuring they reflect current market conditions.

This makes indices especially suitable for:

• Beginners

• Long-term investors

• Traders seeking market-wide exposure

Diversification and Risk Management

Indices naturally offer diversification because they include many companies across sectors or regions. Investors can further diversify by holding multiple indices with minimal overlap.

For example:

• Equity index + bond index

• Equity index + real estate index

Such combinations help reduce portfolio risk and smooth long-term returns.

Low Costs

Index ETFs typically have very low management fees. Some popular funds charge expense ratios as low as 0.03%, making them one of the most cost-efficient investment vehicles available.

Note: Trading indices via CFDs or options involves different cost structures, such as spreads, commissions, and overnight fees.

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Cons of Trading Indices

Lack of Active Management

Index funds rise and fall with the market. During downturns, investors cannot selectively remove poor-performing companies, unlike actively managed portfolios.

Limited Upside Potential

Because indices are diversified, they rarely deliver explosive returns seen in narrowly focused stock or sector strategies.

Exposure to Systemic Risk

Indices are vulnerable to macroeconomic and geopolitical events such as recessions, interest rate shocks, or political crises.

Tracking Errors and Overnight Gaps

Index funds may not perfectly mirror their underlying indices due to fees, liquidity constraints, or rebalancing delays. Additionally, global news can cause overnight price gaps between market sessions.

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1.4 Major Stock Market Indices Around the World

United States

• S&P 500 – Tracks ~80% of US market capitalisation

• Dow Jones Industrial Average (DJIA) – Price-weighted index of 30 blue-chip companies

• Nasdaq 100 – Focuses on large non-financial and technology-driven companies

United Kingdom

• FTSE 100 – Tracks the 100 largest companies listed on the London Stock Exchange

Germany

• DAX 40 – Represents 40 of Germany’s largest and most liquid companies

Australia

• ASX 200 – Tracks the 200 largest stocks by float-adjusted market capitalisation

Hong Kong

• Hang Seng Index – Covers major blue-chip companies representing a large portion of the Hong Kong market and Asian economic activity

These indices serve as key benchmarks for investors, traders, and policymakers worldwide.

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1.5 Market Timings and Global Trading Sessions

Stock exchanges operate during set business hours, typically Monday to Friday. Trading hours vary by country and region, and some Asian markets observe midday breaks.

Different cultures and religious practices also influence trading schedules—some Middle Eastern markets operate on weekends.

Understanding global market timings is essential for:

• Managing volatility

• Avoiding overnight risk

• Planning international trading strategies

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1.6 How Are Indices Calculated?

Market Capitalisation-Weighted

The most common method. Larger companies have greater influence on the index.

Used by:

• S&P 500

• Nasdaq 100

• DAX 40

Price-Weighted

Stocks with higher share prices have more impact, regardless of company size.

Used by:

• Dow Jones Industrial Average

Equal-Weighted

All companies have equal influence, reducing concentration risk.

Used by:

• S&P 500 Equal Weight Index

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1.7 How Can You Trade Indices?

Index CFDs

• Speculate on price movements without owning assets

• Trade both rising and falling markets

• Leverage available (higher risk and reward)

• No dividend entitlement

Index ETFs

• Own shares in funds tracking indices

• Eligible for dividends

• Suitable for long-term investing

• No leverage

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Quick Comparison: Index CFDs vs Index ETFs

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Module 1 Recap

• Indices are benchmarks that measure market performance

• They provide diversification, convenience, and insight into market conditions

• Major global indices represent national and regional economies

• Indices are calculated using different weighting methods

• Traders can access indices via CFDs or ETFs depending on strategy and risk tolerance