A stock index, formed by various rating agencies, is basically a representation of the stock market that shows how it is performing as a whole. The index tracks many stocks that indicate the stock market performance as a whole or a specific sector of a stock exchange.
Stock Index Trading
Stock Index trading refers to buying and selling a basket of stocks that make up the stock index. Traders gain exposure to the entire market instead of being limited to the performance of a single stock; therefore, it is referred to as the easiest way to diversify portfolio risks. A number of retail investors trade indexes either as investment or hedging or arbitrage mechanisms to manage risk.
Method of Stock Index Trading
The stock indexes cannot be traded directly as an index is just a benchmark. You cannot make either a long or short trade on the stock indices, but traders can long or short in the derivative market based on futures or options. Futures markets are available for all stock indexes.
To trade futures and options, you do need an online Demat account, like share trading, as they are more like contracts than an asset and valid for a limited period. Demat meaning is simply the electronic form, as in the Demat account. You can simply open your trading account with a broker offering a flat rate brokerage plan.
Cost of Stock Index Trading
- A big advantage of trading indexes is the minimum of research as compared to trading individual stocks. For example, if you decided to invest in all the stocks of NIFTY 50, you would have to analyze 50 stocks that could take weeks to research. It is difficult to track every stock.
On the other hand, if you invest in the NIFTY 50 index comprising the same types of stocks, you can focus on just technical analysis of the index.
Index trading requires passive management that requires charting the stock indexes and not every stock. Thus, it does not include huge research costs.
- Commission rates, STT rates, and execution costs on index trading are also very low than equities or even stock futures, maybe just 0.5% of the contract value, and are charged when the position is closed. However, such costs depend on services provided by the stockbroker.
Most brokers offer fixed brokerage packages on index trading also makes it more economical.
- Like the profitability and risk analysis, the cost is also an important factor when evaluating trading strategies for the stock index. Stock index trading strategies are unique, such as hedging and arbitrage. Different trading strategies are distinct in terms of benefits and costs.
- The cost of the index trading strategy includes the occupation of capital and impact cost. Occupation of capital is the capital that a trader needs to pay for the transaction. Market impact cost is the loss due to affected market trends. The cost is higher for arbitrage traders as compared to technology traders, and noise traders.
- Futures markets usually advance in sync with their underlying indexes. Therefore, charting is feasible for the indexes while trading the futures markets. Hence, the fact is that benefits, costs, and risks associated with trading strategies get affected by the behavior of investors towards the index and overall operation.
In the end, index futures are well-regulated contracts in India. Greater leverage, low-cost trading, and a longer trading period are among the advantages of futures. Leveraging is perhaps one of the reasons that make it a popular derivative instrument. However, leveraged positions must be traded with stop losses.