Stock indexes, such as the UK’s FTSE 100 and the S&P 500 (as well as the Dow Jones Industrial Average) out of the United States, are an important part of the financial market and are frequently acknowledged in the evening news and across major financial networks.
Yet a stock index is nothing more than a statistic, a value, in the case of the S&P 500 for example, representing 500 of some of the largest companies (individual stocks such as Amazon and Apple) listed in the US.
Stock indexes are calculated using different formulas, including the market capitalisation weighed method and the price-weighted method. It’s also important to realise a stock market index, the cash price, cannot be directly traded.
However, index trading (or indices trading) can be achieved through derivatives, products that track the underlying cash price. Futures contracts, for instance, track underlying assets and represent an agreement to buy/sell a particular asset at a predetermined price at a specified date in the future.
Trading financial instruments (global markets such as Forex [currency pairs], Cryptocurrencies, Individual stocks [stock CFDs], Commodities and Stock indexes [index CFDs]) through a CFD provider, however, clients are permitted to trade futures contracts via CFDs (contract for difference). CFDs work by mirroring the front-month futures contract trading on the exchange, providing traders a cost-effective way to engage with the markets (CFD providers add a small spread as commission).
The cash price CFD brokers offer on stock indexes, which are tradable as they’re based on CFD contracts, are the broker’s products, their own index. As such, you’ll notice CFD stock indices trade under different titles, such as the US 500 or UK 100. Theoretically, CFD providers take the futures contract and adjust price to resemble the underlying cash index (which, as we already know, is not tradable). This is because retail traders tend to focus on the published cash price and want to trade this. For that reason, brokers offer similarly priced CFD products, available on MetaTrader trading platforms.
Retail investor accounts can execute long positions as well as short positions when CFD trading, with favourable trading hours.
Day Trading Indexes
Day Trading often involves buying and selling derivative products and liquidating positions before the close of the trading day. Recognising the short-term nature of day trading, efforts tend to be focused on technical analysis; fundamental analysis is more motivated towards longer-term movement.
Technical analysis has grown in popularity over the years, an approach that examines historical price action to help forecast future moves.
The field of technical analysis is substantial, boasting a broad array of trading strategies and several different trading styles. Still, the majority of experienced day traders choose to keep things simple.
Trendline studies are popular among day traders, specifically price action traders.
When applied correctly, trendlines define the short term-trend and inform when a trend might be losing steam. The more times a line is tested, the stronger it is considered to be. The general rule of thumb in technical analysis is it takes two points to draw a trend line with the third point confirming strength. However, many traders consider the third test tradable, as shown in figure 1.A, a H4 chart of the S&P 500.
Rupturing the aforementioned trendline support does not necessarily signal a definite trend change. What is does indicate is reluctance to hold things higher, which may be sign sellers are taking control. By and of itself, these signals bearish strategies could worth exploring.
FIGURE 1.A – S&P 500 H4 chart provided by Trading View
Supply and demand areas are also regularly used among the day trading community. Like trendline studies, supply and demand falls under the classification of price action trading. In fact, these two concepts converging on charts can highlight particularly potent confluence.
Supply and demand zones tend to work better when the areas form decision points. As an example, again using the H4 chart of the S&P 500 (figure 1.B), we can see a fresh demand, albeit a relatively small zone, formed before penetrating the July 23 high at $3,293.8. This indicates the demand area fashioned enough force, or buying pressure, to overthrow the previous structure, emphasising strength.
Although the article has so far used H4 charts, which are typically used by swing traders, the examples shown can be used on ANY timeframe, therefore suitable for all trading styles, including day trading. This is one of the major benefits of technical analysis: its flexibility.
FIGURE 1.B – S&P 500 H4 chart provided by Trading View
Technical trading indicators are common tools used to analyse the intraday price movement. Among the many technical indicators available, the relative strength index (RSI), the moving average convergence divergence (MACD), Bollinger bands and moving averages tend to be the most widely used.
Whilst going through each indicator in detail is beyond the scope of this article, moving averages have stood the test of time and are important to understand.
Largely employed to decipher trend by smoothing short-term fluctuations, a moving average is essentially an individual value representing a net of previous numbers. For example, a 50-day moving average is one number based on the past 50 price points, usually the daily close.
Moving averages can be used on any timeframe. The most popular settings are 5, 10, 20, 50, 100, and 200. Periods highlighted in bold are widely used by day traders to measure a short-term trend. The 50- and 100-period settings help gauge mid-term trend, while the 200-day setting is often used by long-term trend followers, and is a key-value on most financial networks. Most technical players look for a CLOSE above/below the 200-day average to indicate the position of a stock index: bullish if above and bearish when below, as in figure 1.C, the S&P 500 daily chart.
Another popular way the 200-day moving average is used is through the Golden Cross and Death Cross strategies. This involves a 200-day and a 50-day moving average. The 50-day average crossing above its 200-day counterpart indicates a possible bullish market and refers to a Golden Cross. When the 50-day average crosses under the 200-day moving average, nevertheless, it is ominously referred to as a Death Cross, pointing to the possibility of downtrend (see figure 1.D).
While the 200-day moving average is largely used by longer-term traders, day traders frequently examine its position to help stay aligned with the overall trend.
FIGURE 1.C – S&P 500 daily chart provided by Trading View
FIGURE 1.D – S&P 500 daily chart provided by Trading View
Like longer-term traders, day traders use moving averages similarly, only on lower timeframes. As demonstrated in figure 1.E, the M15 chart of the S&P 500 has a 30-period moving average applied. What’s clear is the fluctuations are more prominent on lower timeframes. Lower timeframes, therefore, can get particularly disorderedly for day traders around moving averages (yellow boxes), though, as you can see in figure 1.E, there were some healthy signals (red arrows) where price movement signalled a short-term trend change.
FIGURE 1.E – S&P 500 M15 chart provided by Trading View
Another popular way day traders (and longer-term traders) use using moving averages are as dynamic support and resistance levels. As shown in figure 1.F, the M15 chart of the S&P 500 has price action rebound from the 30-period moving average on a number of occasions (yellow).
FIGURE 1.F – S&P 500 M15 chart provided by Trading View
This article has barely scratched the surface concerning the ways a day trader can technically engage with stock indexes.
Breakout trading, trend trading (trends form on all timeframes), range trading, and reversal trading are the most common trading approaches used to search for trading opportunities.
- Breakout trading involves waiting for a support or resistance level to break and then attempting to trade the breakout direction. This can also lead to an intraday trend forming.
- Trend trading on all timeframes is popular. Catching a trend at the right point, using a moving average, for example, can be incredibly rewarding.
- Range trading entails waiting for a consolidation to form, with definable support and resistance levels that can be faded.
- Reversal trading involves locating points on the chart a reversal may form, such as support and resistance.
Irrespective of the trading approach employed to trade indices, ensure you trade with a defined trading plan. This is formed through rigorous backtesting and forward testing on demo accounts and small live accounts.
Disclaimer: The information contained in this material is intended for general advice only. It does not take into account your investment objectives, financial situation, or particular needs. FP Markets has made every effort to ensure the accuracy of the information as at the date of publication. FP Markets does not give any warranty or representation as to the material. Examples included in this material are for illustrative purposes only. To the extent permitted by law, FP Markets and its employees shall not be liable for any loss or damage arising in any way (including by way of negligence) from or in connection with any information provided in or omitted from this material. Features of the FP Markets products including applicable fees and charges are outlined in the Product Disclosure Statements available from FP Markets website, www.fpmarkets.com, and should be considered before deciding to deal with those products. Derivatives can be high risk; losses can exceed your initial payment. FP Markets recommends that you seek independent advice. First Prudential Markets Pty Ltd trading as FP Markets ABN 16 112 600 281, Australian Financial Services License Number 286354.