Indices are some of the most popular marketplaces in the world, where those with a strong trading strategy can make large returns as well as large losses. Many people are unaware, however, that certain tactics are more suited to index trading than others.
Trading indices allow traders to trade a diverse portfolio of stocks through a single index, reducing their risk in the financial markets. There are various index trading strategies available to help traders identify optimal market entry and exit points.
Note that the best trading strategy is like your fingerprint – it is unique to you – and will involve a blend of fundamental and technical analysis that is tailored to your trading style, favourite trading indicators, and risk management technique.
What are Indices Trading?
The trading of an index is the trading of a set of securities that comprise the index. You trade an index as a whole based on the average performance of all securities combined.
The index value can be derived by adding the prices of all securities and dividing it by the number of stocks.
The Best Index Trading Strategies
1. The Bollinger Entry Approach
The Bollinger entry approach identifies oversold market areas and gives traders optimal market entry levels. It is divided into three bands:
- The centre band is the index price’s simple moving average.
- The upper band denotes high market prices.
- The lower band denotes low market prices.
Traders use this approach to look for price breakouts above the upper band, which indicate a continuing uptrend. As a result, traders enter long trades when index prices move over the top band on the indices’ price chart.
2. Trend Trading Strategy
In principle, this is one of the simplest methods to grasp: correctly predict the market’s direction and capitalise on an index’s upward or downward spike or change of direction.
Traders use the Trend trading method to enter or exit trades during a predetermined continuous trend. When the index is trading in one way, traders think that it will continue to move in that direction over time and make long or short trade decisions accordingly.
- When the index is trading upward, traders place a long or buy position with the hope that the uptrend will continue.
- When the index is trading down, traders enter a short or sell position with the idea that the downturn will continue.
3. Breakout Trading Strategy
The term “breakout trading strategy” refers to determining an area in which the index price has been trading over time. As the index price rises outside this range, a breakout occurs, signalling traders to enter or depart the market.
Index traders use this method to enter trades as soon as a specific market trend begins.
When such an index price breaks above the resistance level, it suggests that the market is continuing to rise and tells traders to enter long/buy positions. When the index price falls below the support level, it shows that the market is continuing to fall and tells traders to enter short/sell positions.
4. Trading Retracements
Indices, like markets, never move in a straight path. As an index price trend emerges, it is highly common for a ‘pullback’ or a retracement to occur, which is when the index’s pricing briefly reverses direction.
This can be either a momentary increase in the price of an otherwise declining index or a drop in the price of an ascending index. The latter is especially crucial to be aware of because trading retracements as a method are frequently employed in positive circumstances.
Stock markets tend to rise over time, although they are prone to volatility. The general rule is to wait for a little decline or rise in the index price. Once the momentary retracement is over, go long (if the index price fell) or short (if it increased). This will allow you to capitalise on the current price movement. As a result, it is most commonly employed by scalpers and other short-term traders.
It should be noted, however, that indices can also experience a reversal, which occurs when the underlying index’s market price reverses its overall direction (from bullish to bearish or vice versa). As a result, if you’re trading a retracement, be sure it’s only a momentary move.
5. Trading reversals
What appears to be a retracement could actually be a ‘reversal,’ in which case you should sell the index. This is a significant movement in the overall direction of an index’s price for a period of time.
During an uptrend, the price of an index would move through a succession of higher highs and higher lows. A dominating downtrend would be characterised by the index’s price moving to a series of lower highs and lower lows.
In the case of a downtrend, the index trading price would move to spike into greater and higher peaks, indicating a general shift in the index’s pricing from downward to upward.
Some indicators, such as a moving average, oscillator, or channel, can assist in identifying trends and reversals.
6. Trading With Momentum
The mantra of someone with a momentum trading approach can be described as: ‘buy high, sell higher’. A momentum index trading technique involves investors going with the flow and buying stocks that are rising and selling them when they appear to have peaked.
The goal here is to work with volatility by looking for purchasing opportunities in short-term uptrends and then selling when the securities lose momentum. As a result, it is frequently best appropriate if you are a scalper, day trader, or utilise other shorter-term trading strategies.
7. Trading Breakouts
Similar to trend trading, a breakout trading strategy involves watching indices closely to determine their patterns and rhythms in terms of volumes, volatility and direction. With this knowledge, you’d aim to enter a trend as early as possible when an index’s price breaks through its normal levels of support and resistance, then trade that trend.
If you use this strategy, you’ll look for price points that indicate the start of a period of volatility or a change in market sentiment on an index. You may also place a limit-entry order around the levels of support or resistance you’ve identified so that any breakout executes a trade automatically.
8. Swing Trading Strategy
Swing trading involves placing trades and holding them for a few days or weeks. Traders use this approach to make little profits in the short term and are affected by minor price movements. Traders enter and leave the market on a regular and repeated basis in order to grab prospective gains in a short to medium timeframe.
Traders receive a signal to enter trades when the index prices continue to rise over a few days. As the index prices continue to fall over a few days, traders receive a signal to exit trades.