Index (plural: indices) trading is much riskier than Forex trading. The large movements that indices always have mean that traders can either record huge profits or incur significant losses.
You can, however, avoid a lot of these losses if you observe basic indices risk management principles.
The principles outlined here should help you reduce risks when trading indices:
Indices figures that look a lot like Forex rates are known to generate lots of pips per time, much more than other instruments. For example, it is not unusual to have the NASDAQ move over a thousand pips in just a few minutes.
That will be extraordinary in any other market, especially in Forex trading. For instance, the forex rates of the EUR/USD, which is the most traded pair, only does about 100 pips daily on average.
That number of pips means that even minimal moves by indices tend to generate either significant profits or heavy losses. Hence, to avoid these losses, you should use the smallest lot size possible.
By now, you are already familiar with the fact that indices generate significant moves per time. These moves are often even greater during important economic news announcements.
Economic reports and statistics are known to move most markets. However, the amount of activity they cause in indices is usually large. For instance, the Dow Jones 30 can move as much as 3,000 pips after the release of the NFP report.
If this move happens in the direction in which you are trading, you will have a significant profit. If it, however, moves against it, the loss will be massive. To avoid all of these, you should stay away from indices whenever you want to trade important market news.
When trading indices, you should use stop orders every time. Indices generate heavy moves, which can mean two things:
- The market can move in the direction of your trade very quickly.
- Or, the trade sharply goes against your prediction and direction within a very short time.
To avoid banking huge losses, you should always set a stop loss for each trade. It is especially important when it comes to indices, that the stop loss should not be too wide so as not to cause heavy losses.
It should, however, also not be too restrictive, as losing trades can reverse to profit. Similarly, a take-profit order is equally important as it will help you realize your profits and prevent potential reversals.
The spreads for indices are usually massive across brokers. However, some brokers offer more favourable spreads than others, and those are the ones you should go for. Large spreads can delay your trade from turning to profit or even heavily contribute to your loss. Thus, you should trade with spreads as minimal as possible.
Another concept that will enable you to trade indices better is correlations.
Whenever there are instruments within the same asset class, investors may be interested in knowing how these markets relate to make better investment decisions. This is because, sometimes, some instruments move together, while some move against one another.
For instance, in Forex trading, a pair such as EUR/USD is known to move closely as GBP/USD. The same is the case for AUD and NZD. The reason is that these currencies are closely related because their economies are interconnected.
That also applies to indices. Some indices move together and some, against each other. They also have this direct and inverse relationship with other assets.
For instance, the S&P 500 tends to move considerably with the Dow Jones (US 30). This is because almost all the companies in the Dow Jones are also on the S&P.
Furthermore, most stock indices move inversely against gold (XAU/USD). Thus, if the NASDAQ is going up, the price of gold will most likely be falling.
Indices trading can be complicated. This is because they involve several stocks. You can, however, avoid all of this complication by signing up with a Forex signal provider that offers indices trading.
With a Forex signal service, you can become profitable in indices trading right away.