What is an Index and why you should consider Indices CFD!

October 15, 2020

Are you currently investing in the stock market, or are you putting it off because of the COVID-19 pandemic? Despite the pandemic, the market has been improving over the past few months and one good way to get exposed to the market as a whole is through Indices CFD!


What is a Stock Index?

How do you know if the market has gone up or down today?

It’s easy – Simply add and compare the sums of money required to buy all the companies at the prices quoted today and yesterday. If today’s figure is greater than that of the day before, then we know that the market has gone up today and vice versa. However, the summation and comparison of numbers can be tedious and troublesome. This brings about the creation of a tool of measurement called the Index.

A Stock Index is simply a collection of stocks (or other assets) that provides an overview of how a specific part of the stock market is performing. Through the use of the Index as a proxy, we can derive whether the market has gone up or down today.

I am sure a good number of you would have heard of some of the major indices, such as the S&P 500 and the Dow Jones Industrial Average (DJIA), which are commonly reported in the news. While most recognise the major indices and some may even have related trading experience, one common misunderstanding is that indices are traded like individual stocks. The truth is, stocks indices are not tradeable directly. However, there are other ways for you to replicate the performance of the index, such as purchasing Index Fund or Index CFD.


Advantages of Trading Indices

1. Diversify Your Portfolio

One of the biggest reasons why indices are popular is that every index is well diversified. As the saying goes, “Don’t put all your eggs in one basket” – buying an index allows you to divide your risk across the stocks within your index. The possibility of a decrease in the share price of all companies within the index is much lower than that of the possibility of a decrease in the share price of a single company on the same day. This means that the decrease in the share prices for some companies can be offset by the increase in share prices of the other companies within the same index on the same day.

However, a lower risk commensurates with a lower return, meaning that massive gains from an index are less likely as compared to an individual stock.

2. Lower Cost and Capital

If you want to be exposed to an index, for example, the S&P 500, the most direct way is buying and owning the stocks of all 500 companies that make up the index. However, is it practical considering the huge amount of capital and cost involved in the transaction?

It is more cost efficient to gain exposure to a stock index via an index fund or Index CFD instead of purchasing multiple stocks. The other advantage of greater cost-saving translates to more money for other investments.

3. Overcome the Paradox of Choice

Ever heard of the term “Paradox of Choice?” Studies have shown that having far too many choices limits our freedom, causing us stress and unhappiness. This happens in investing as well.

It is not uncommon to hear about people struggling hard over which stocks to purchase, and having no clue despite their research. Instead of facing the dilemma of choice, you can opt for indices which are useful tools for investors to adopt a passive approach towards investing. This is especially handy for those who have no time to research and monitor the stock market.


Disadvantage of Trading Indices

1. No voting rights

By purchasing an index fund or CFD Index, you are not entitled to any voting rights of the companies that make up the index.

2. No control over holdings within the Index

Individual investors cannot amend the individual holdings within the portfolio based on his/ her preferences. For example, if you have a specific company that you would like to own or exclude, you cannot remove them from your portfolio directly.


Why Indices CFD?

A Contract for Differences (CFD) is an agreement between two parties to exchange the difference in value between the opening and closing of the contract. CFDs allow you to participate in the price movement of an underlying asset without actually owning or taking physical delivery of the underlying asset.

One of the easiest and most popular way to trade or gain exposure to stocks indices is via CFDs. Through Indices CFDs, you can participate in the price movements of the underlying index. Indices CFDs also allow you to go either long or short the underlying asset to capitalise in both bullish and bearish market conditions.

CFDs are leveraged products that are traded on margin, which means that you are only required to put up a fraction of the contract value as margin to open a position, instead of paying the full value of the underlying asset. While leverage can help magnify your returns if the market moves in your favour, it can also magnify your losses if the market moves against you. Hence, your losses may exceed what you deposit.

Let’s go through an example to better understand the impact of leverage. Assuming that you buy one contract of US Tech 100 at a price of USD11,700 without any finance charges and commission imposed.

Contract Specifications of US Tech 100 Index USD5 CFD

Value of 1 Index Point: USD 5
Contract Size: USD 5 x Index Price x Quantity
Target Spreads (points) 1
Commission: USD 0.99 per side / contract
Long Finance Charges (DR): 4.50% p.a.
Short Finance Charges (DR): 2.75% p.a.
Margin Requirements 6%

With Leverage using
CFD
Without Leverage
Initial contract Value
USD58,500

USD11,700 X 5 = USD58,500

USD58,500

USD11,700 X 5 = USD58,500

Initial Capital
USD3,510

6% x USD 58,500 = USD 3,510

USD58,500
Gain when Position Close higher at 12,000
USD1,500

USD 12,000 X 5 = USD 60,000
USD 60,000 – USD 58,500 = USD 1,500

USD 1,500

USD 12,000 X 5 = USD 60,000
USD 60,000 – USD 58,500 = USD 1,500

Return on Equity
43%

USD 1,500/ USD 3,510 = 43%

2.56%

USD 1,500/ USD 58,500 = 2.56%

Loss when Position Close Lower at 11,400
– USD1,500

USD 11,400 X 5 = USD 57,000
USD 57,000 – USD 58,500 = – USD 1,500

– USD1,500

USD 11,400 X 5 = USD 57,000
USD 57,000 – USD 58,500 = – USD 1,500

Return on Equity
– 43%

– USD 1,500/ USD 3,510 = – 43%

– 2.56%

– USD 1,500/ USD 58,500 = – 2.56%


Optimise your trades with USD1 Index CFD!

Looking at the example above, we see that a contract of US Tech 100 Index USD5 would require a margin of USD 3,510. It is good practice to maintain a buffer when trading in leveraged products. In other words, you should hold quite a fair amount above USD3,510 if you wish to hold a contract of US Tech 100 Index USD5 CFD. In reality, quite a significant sum is required to trade one of these contracts. This can be an issue for those who wish to invest a small amount in the Index, and those who are new to index trading.

Factsheets


Good news! We are offering two new indices – the US Tech 100 Index USD1 CFD and US SP 500 Index USD1 CFD, which are only one-fifth the contract value of the current contracts. In other words, they allow you to gain exposure to the respective underlying indices with only one-fifth the capital requirement of the current contracts.

Below is the description of the two new indices:

Contract Specifications of US SP 500 Index USD1 CFD

Value of 1 Index Point: USD1
Contract Size: USD1 x US SP 500 Index USD1 CFD Price x Quantity
Margin Requirements: 6%

Description of US Tech 100 Index USD1 CFD

Value of 1 Index Point: USD1
Contract Size: USD1 x US Tech 100 Index USD1 CFD Price x Quantity
Margin Requirements: 6%

Let us go through an example of how this would impact your margin requirement. Suppose you buy 1 contract of US SP 500 Index USD1 CFD vs US SP 500 Index USD5 at USD3,400. Price closes at USD 3,500.

For simplicity, let us assume that there are no finance and commission charges involved.

US SP 500 Index USD5
US SP 500 Index USD1
Initial Contract Value
USD17,000

USD3,400 X 5 = USD17,000

USD3,400

USD3,400 X 1 = USD3,400

Closing Contract Value
USD17,500

USD3,500 X 5 = USD17,500

USD3,500

USD3,500 X 1 = USD3,500

Gain/ Loss
USD500
USD100
Minimum Margin Requirement
USD1,020

6% X USD17,000 = USD1,020

$204

6% X USD3,400 = $204

Return on Equity (using CFD)
49%

USD500 / USD1,020 = 49%

49%

$100 / USD204 = 49%

From this, we can see that although the new Index requires a smaller margin, it maintains the same returns on your equity. This allows you to buy “part” of an Index CFD, giving you greater flexibility in your investment strategy. Furthermore, this allows investors who do not have a huge capital to participate in the index.


Smaller Contracts, Greater Flexibility

Factsheets


Click here for more information on our newly launched USD1 Index CFDs and trade with greater flexibility now! Be sure to check out our other articles and the free webinars courses that we offer. If you have any questions on trading or investing, feel free to drop us an email at cfd@phillip.com.sg and we will be glad to assist you through your investment journey.


Begin your Indices CFD Trading Journey now!

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About the author

Mr. Jason Chua
Dealer

Jason Chua graduated from Singapore Institute of Management (University of London) with a Bachelor’s Degree in Banking and Finance. He has experience working as a proprietary trader and banker before joining Phillip Securities.

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