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Indices Trading: Understanding The Differences Between Investing & Trading Indices

If you want to get exposure to market indices like the Straits Times Index, you can choose to invest in it or trade.

 

This article was written in partnership with IG, the world’s No.1 CFD provider (by revenue excluding FX, 2016). All views expressed in the article are the independent opinion of DollarsAndSense.sg

In recent years, index investing has become increasingly popular among investors. As a result, a greater number of index-linked exchange-traded funds (ETFs) have been created to meet this growing demand from investors.

Not wanting to be left out, more traders are now also exploring avenues to trade indices. Similar to stocks, forex and commodities, a person can both trade and invest in indices.

But what are the differences between the two?

Holding Period – Indices Trading Vs Investing

One of the main difference between trading and investing is the intended holding period for traders and investors.

For investors, the aim is usually to invest today with the expectation that the investment will increase in value over the long-term. Holding period for the indices invested can range from anywhere between a few years to even 10 or more years.

When it comes to trading, the mind-set that traders adopt is that prices will always fluctuate. A trader aims to make profit through successfully capturing the changes in prices over the short-term, whether in minutes, days or weeks.

In contrast to investing, traders can go long (buying the indices with the expectation that prices will go up) or short (selling the indices with the expectation that price will decline). Successful traders can earn a profit from indices, regardless of market conditions.

Ownership Of The Underlying Assets

Another key difference between investing and trading an index is the ownership of the underlying indices.

Unlike investing in an index-linked ETFs such as the Nikko AM Straits Times Index (STI) ETF, where you actually own the underlying assets that you buy, when it comes to indices trading, you may not necessarily own the underlying assets that you are trading.

That’s because for indices trading, traders typically use an index CFD. Index CFDs allows traders to get exposure to the indices of their choice, and also allow them to go both long and short in the market, without having to invest into the underlying asset.

A trusted broker that provides access to more than 30 indices around the world is IG. They offer traders access to diverse indices markets including the US Tech 100, which is basically the NASDAQ, the Hong Kong HS50, which is the Hang Seng Index and the Singapore Index, which is essentially the STI.

Read Also: What Are CFDs And When Should Traders And Investors Use It

Employing Leverage

When it comes to trading, most, if not all, traders will employ some degree of leverage. The reason for this is simple, leverage, when utilised correctly, can help traders increase their profits without having to fork out much cash.

For example, a trader who puts down an initial capital of $5,000 is able to leverage up to 20 times his capital (i.e. $100,000) if he trades the Singapore Index offered by IG. If he enters into a $50,000 position for his trade, a 1% increase ($500) in the Singapore Index will translate into a 10% return ($500/$5,000) on his initial capital.

Of course, leverage is a double-edged sword. If the market moves against a trader’s position, the losses incurred will likewise be magnified. This is why it’s essential for traders to learn how to protect themselves when they first start trading.

This is different to investing, where most investors typically only invest with money they already have, without the use of any leverage.

Read Also: Investing Or Trading The Straits Times Index (STI) – Which One Is More Suitable For Me?

Are You Investing Or Trading ?

Some people invest/trade into indices without recognising the differences between the two.

For example, an “investor” may think that indices prices are low today and may want to make a quick profit in the next 1-2 weeks when prices recover. However, that is typically considered trading rather than investing.

When you compare between the two, indices trading tends to require quite a fair bit more skills than investing. That’s because there are more factors to consider including having a trading methodology, entry & exit strategies, use of leverage and even the need to learn technical analysis.

If you are keen to explore trading, we recommend you do more self-learning from articles and books available online. You can also attend seminars or  webinars such as the ones available from the IG Academy – a free resource designed to help traders of different trading literacy to progress and become better traders.

If you wish to learn more specifically about volatility, and how it presents both opportunity and risk for investors and traders, IG have collaborated with Bloomberg Media Studios to publish a free-to-download eBook which condenses trending and need-to-know topics surrounding volatility. You can download this eBook here.

If you are keen to try your hand at trading, we also recommend that you start off with a free demo account first.

Read Also: [Beginners’ Guide] How To Start Trading In Singapore