Index CFD’s work precisely the same way as regular CFDs, except they only allow the trader to trade on indices instead of individual shares/stocks.
Even though indices have a certain degree of protection from individual company-related news, this does not mean that you will never suffer any losses. This is simply because indices comprise hundreds of companies, and parts of indices can still be affected by external events such as emerging markets or commodity prices.
Benefits of index CFD trading
This type of trade offers several benefits to both traders and the companies that provide the underlying assets for these trades.
Individual and multiple shares
One of the main advantages of index CFD trading is that investors don’t need to purchase multiple shares to gain exposure to stocks or other assets. With this type of trade, an investor can potentially benefit from growth in stock prices without actually needing to buy individual shares.
There are similar options available for investing in commodities like oil or precious metals with index CFDs. It is important to note that this type of derivative differs from traditional investing in several key ways. For example, unlike some other types of derivatives, most index CFDs do not allow for hedging against risks and require that traders take on significant risk.
No trading experience needed
Another key advantage is that traders can potentially profit from index CFD trading even if they are not highly experienced in the markets or do not have a lot of capital to start investing with. When it comes to many types of derivatives, including traditional stocks and shares, investors need to purchase enough shares for their investment to be worthwhile. With most types of index CFDs, this is not necessarily the case.
This means that novice investors who may only have a few hundred dollars to invest might still be able to benefit from growth in stock prices. This can be especially beneficial when compounded over time, which makes index CFD trading an appealing option for long-term investments as well as short-term trades.
Risks associated with index CFD trading
Many people use index CFD’s to try and make a profit on the stock market. Unfortunately, most of these people will lose out in the long run because they fail to understand all risks of Index CFD trading.
Underestimating the commission charges
If you buy or sell an index CFD through your current account that doesn’t offer commission-free trading (like HSBC Premier), you will soon start to lose money as small commissions can add up very quickly. It’s important to remember to look at the exchange rate and take into account any commission charge that applies for opening and closing a position.
Some contracts for difference offer guaranteed stops
This means that if the CFD price moves against you by more than your guaranteed stop level, then your trade will be closed at no additional cost. Unfortunately, many traders fail to realize that it can be ‘stopped out’ but still lose money overall due to commission charges and margin rates.
Currency risk
Some currencies fall faster than others, so it’s essential not to take too much exposure to any one currency without first researching. For example, during 2008/2009, most emerging market currencies fell sharply against the dollar, so an Index CFD traded in Indian Rupees would have yielded no profit even though the stock index was up by 80%.
Finally
A final piece of advice, if you plan on trading CFDs, try a demo account from Saxo Bank so you can test your strategy and check the price movements before actually putting real money in. Index CFD trading can be very risky for those who don’t fully understand the associated risks, so it’s essential to use a reputable online broker who offers low commissions and excellent customer service; read more here https://www.home.saxo/en-sg/products/cfds.