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Find out the purpose of major and minor stock indices and how they are compiled. Learn how to gain exposure to these volatile markets through some of the most popular trading products in the world.
|Indices explained||Pricing and weighting||Futures||Ways to trade|
|What is a stock index?Indices to watchTypes of indicesHow can I trade a stock index?||How are indices priced?How do dividends affect index prices?||Trading index futuresWhy trade stock index futures?Limitations||CFDsOptionsDigital 100sFutures|
Index futures are the primary way of trading stock indices.
All of the major stock indices have corresponding futures contracts that are traded on a futures exchange. The mini South Africa 40 is the main futures contract on the South Africa 40, for example.
Index futures are essentially the same, and trade in the same way, as all other futures contracts.
Taking a long position
This means that you are buying the index at a fixed price now, for expiry on a set date in the future. You would do this if you expected the price of the index to rise between now and the expiry date, so you could profit by selling for a higher price than you paid.
Taking a short position
This would mean that you are selling the index at a fixed price now, for expiry on a set date in the future. You would do this if you thought the price of the index would fall between now and the expiry date, so you could then profit by buying at a lower price.
Like other futures markets, index futures trade on leverage: you put down a margin of the total value of your contract, and this gives you magnified exposure to the market.
Example: the mini South Africa 40 future index
The mini SA40 future contract is one fifth of the size of the standard contract, and closely tracks the performance of the larger index. If you think the SA40 is going to increase in value over the next three months, you might choose to buy index future on the mini SA40.
The contracts are priced at R10 x the mini future (futures) price. So if the mini futures price is at 1000.00, your R10 contract has a full exposure worth R10,000 (R10 x 1000.00). Like all futures products, you only need to put down a fraction of the full value of the contract in order to open a position; in the case of index futures, this amount is known as a 'performance bond'. If the market moves against you, you might need to add additional funds to maintain the necessary margin.
For every point the mini SA40 moves in your favour, you gain R10. For every point the mini SA40 moves against you, you lose R10.
Ticks are the minimum price movement of a futures contract. For the mini SA40, the tick is 1 index point, which equates to R10; so if the mini SA40 price moves from 1000 to 1001, a buy position would gain R10 and a sell position would lose R10.
As a form of derivative, futures can fit into your overall trading strategy. In volatility trading, for instance, the aim is to take small but regular profits from a volatile market.
If you have a portfolio of shares, you can limit your exposure to unwanted risk by opening an opposite position as an index future. So if you had a number of long shares positions, you could take a short position on the relevant index future. This would help you to offset any losses if your shares moved against you.
Being leveraged products, stock index futures give you exposure to a stock market or sector as a whole for a much smaller amount of up-front capital, and without having to purchase the individual constituent shares directly.
Futures contracts are standardised by the exchange, which mean you must trade in a certain size. This size might not exactly match your needs, especially if you are hedging an existing portfolio.
As you are dealing with such a high-value and volatile asset, you're likely to need to put down a fairly substantial figure as your margin payment. You’ll need to maintain this margin throughout the time your position is open.