Why indices matter to business readers
Indices are the shorthand of financial news. When a bulletin says "markets fell today", it usually means a handful of benchmark indices fell.
Company boards track them, and fund managers are judged against them.
The US Securities and Exchange Commission's investor site, Investor.gov, describes indices as a way to measure a whole market or sector through a representative group of stocks. You can't buy an index itself. You buy a product that follows it.
How weighting changes what you're betting on
Two indices can both claim to track "the US market" and still behave differently, because they weight their members in different ways.
S&P Dow Jones Indices, which runs both of the indices below, explains the difference in plain terms.
Price-weighted: the Dow
The Dow is price-weighted, so companies with higher share prices have more influence on the index.
A $10 move in a $400 stock moves the Dow by exactly as much as a $10 move in a $40 stock, even if the cheaper share belongs to a far bigger company.
That is why the index's managers have kept very high-priced stocks out of it.
Market-cap weighted: the S&P 500
The S&P 500 is weighted by float-adjusted market capitalisation.
That means each company's share price multiplied by the shares actually available to trade.
The bigger the company, the more it moves the index.
In practice, the largest companies have the most influence on its daily moves, so trading the S&P 500 partly means taking a view on them.
The practical takeaway is to look up how an index is built before you trade it. It tells you which companies are really driving your result.
Three ways to get index exposure
Most people reach indices through one of three products. They suit very different goals.
Index funds and ETFs | Index futures | Index CFDs | |
|---|---|---|---|
What you hold | Units in a fund that owns the shares | An exchange-traded contract with a set expiry | A contract with a provider, settled on price changes |
Typical horizon | Years | Weeks to months | Hours to weeks |
Leverage | None, unless you borrow | Built in through margin | Built in through margin |
Main costs | Annual fund fee and brokerage | Commissions and exchange fees | Spread and overnight financing |
Can you lose more than you put in? | No, unless you borrowed | Yes | Depends on the provider and regulator |
Contracts for difference (CFDs) come in two forms. Cash index CFDs follow the current level of the index and have no expiry date, but they usually charge financing for every night a position stays open.
Futures-based CFDs track an index futures contract, expire on a set date and often carry a wider spread, which can make them more practical for longer holds.
The risks that come with leverage
Leverage lets a small deposit control a much larger position, which magnifies both gains and losses. Regulators in several countries limit it for retail clients.
In Australia, for example, ASIC caps leverage on major stock market indices at 20:1. At that level, a 5% fall in the index wipes out the entire deposit on a fully leveraged position.
A few other risks are specific to indices:
Indices can gap when markets reopen after a weekend or a holiday, so a stop-loss may close your trade at a worse level than you set.
Index CFDs often trade outside the underlying exchange's hours, when prices can be thinner and more volatile.
Market-cap weighting concentrates risk in the largest companies, so an "index" position may be less diversified than it looks.
Providers that offer indices trading through CFDs typically list each index alongside its trading hours, whether it is a cash or futures product, and the margin it requires.
Read those terms, check the provider's licence with the regulator in your own country, and compare the cost of holding a position for a week, not just for a day.
Frequently asked questions
Is trading an index safer than trading a single stock?
What's the difference between an index fund and indices trading?
Which index should a beginner watch first?
Indices are one of the clearest ways to follow a whole market, and indices trading lets you act on a view of that market without choosing individual stocks.
Before you trade, know how the index is weighted, decide whether you want long-term ownership or short-term exposure, and treat leverage as the main source of risk rather than a bonus.
