Choosing a market for CFD trading
Trading CFDs on stock indices
As a stock index is essentially just a benchmark number representing a group of shares, you can't buy or sell it directly on an exchange (known as the cash market). You could of course trade each of the individual constituent stocks in their relevant weightings, but this would be a complex and inefficient process.
So the practical way to trade stock indices is via derivative futures contracts, bought through a bank or futures broker, or other derivative products like CFDs.
Did you know?
CFD providers create their own stock index markets with prices derived directly from the futures market for each underlying index. You’ll notice that CFD markets usually have different names to the underlying indices. This is because the actual stock indices are calculated, owned and trademarked by various organisations – for example, the Dow Jones Industrial Average is owned by S&P Dow Jones Indices, while the German DAX is operated by Deutsche Börse – so their names can’t be used.
Here’s an example of a few of the markets IG offers:
|Underlying index||IG's market|
|S&P 500||US 500|
|Dow Jones||Wall Street|
|CAC 40||France 40|
|DAX 30||Germany 40|
|ASX 200||Australia 200|
|Nikkei 225||Japan 225|
|FTSE 100||FTSE 100*|
*IG has special dispensation to use the FTSE 100 name. Most other providers call this the 'UK 100' or similar.
Unlike shares, forex or commodities, there are no direct buy or sell prices for underlying stock indices. Each index has a unique value which is calculated on an ongoing basis. Your CFD provider’s buy and sell prices will generally be wrapped around this value, but being based on the futures market they may not be aligned precisely with it.
For example, say the NASDAQ-100 June futures market is at 4600, and your provider is offering a two-point spread on its version of this market. This means it will add a spread of one point either side of the current value to create a price of 4599/4601.
IncorrectA four-point spread means the 'buy' price will be two points above the DAX's current market value, while the 'sell' price will be two points below.
The value of an actual stock index doesn't change when the underlying market is closed. For example, the London Stock Exchange is open from 8:00am to 4:30pm (UK time) from Monday to Friday, and outside of these times the FTSE 100 doesn't move as none of its constituent stocks are being traded.
However, the underlying futures market is open longer: for example, FTSE futures trade from 01:00 to 21:00. So futures prices move with fluctuations in supply and demand while the stock exchange is closed, and so do the CFD prices derived from them.
Of course, there are still periods when both the stock and futures markets are closed (four hours in the case of the FTSE). You may be surprised to learn that some CFD providers are nevertheless able to offer prices for their clients to deal on during these times.
To do this they use the performance of other markets around the world – generally other stock indices – to predict how that index should be priced. By applying a mathematical formula to these related markets, providers can derive a ‘buy’ and ‘sell’ price for the closed index. These prices will also fluctuate based on the business that the provider receives while the underlying market is closed, as well as any news events that could influence the index concerned.
It’s important to remember that these out-of-hours prices can be very different to those that will be available when the market next opens. So although out-of-hours dealing enables you to capitalise on opportunities while markets are closed, there’s also the risk of incurring a loss that would have been avoided if you had waited.
In addition, since there’s no market available to validate out-of-hours prices, you’ll find that most providers offer wider spreads during these periods. This gives them a better chance of reflecting the underlying index level accurately in their pricing.
Here are the typical spreads offered by IG at different times on the FTSE 100 cash CFD market:
|Time period||Dealing spread|
|08:00-16:30 ('in hours')||1|
Impact of leverage
When you trade CFDs on stock indices, you'll need to put up a margin payment which may only be a small proportion of the value of your position. Remember that your potential loss could be much greater than this, however.
- Because indices are essentially just numbers that can’t be bought or exchanged, you can’t trade them in the traditional way
- CFD providers enable you to speculate on indices by providing their own markets which ‘shadow’ the underlying index value
- Buy and sell prices for indices are created by wrapping a spread around the value of the index
- Some providers offer CFD trading on indices outside of market hours, generally with wider spreads at these times