How Does an Index CFD Work?

Indices measure the performance of a group of stocks together instead of individual stocks. With index CFDs, you get to trade the world's top financial markets in a balanced way without having to analyze the performance of every individual stock that forms up the index. More importantly, CFDs allow you to trade with increased leverage and purchasing power.

Interested in trading index CFDs? Take a look at how they work.

What is an Index CFD?

An Index CFD is a type of contract for difference that uses index futures contracts as the underlying asset. You can trade indexes through CFDs without actually owning the indices directly. 

An index is the collective performance indicator of multiple securities. For example, suppose you are trading 5 securities A, B, C, D and E, with each security's price being $2. In that case, the index will be calculated by adding each security's price and dividing it by the total number of securities. Hence, index of A, B, C, D and E = $10/5 = $2. 

When trading Index CFDs, the index prices mirror the Index CFD prices, and the contract only expires right before the future contract’s expiration date. 

The major difference between trading indices and an Index CFD is that Index CFDs allow leverage trading, giving you higher exposure into the market even with lesser capital. 

You can trade several Indexes from S&P500, NASDAQ100, The Dow Jones Industrial Average to Nifty50, EuroStoxx 50 and more.

How do Index CFDs work?

In Index CFD trading, you agree to a contract with your broker, including the index name, value, and the total number of units you are purchasing. As the index CFD prices change, you profit from the opening and closing price difference.

When you trade Index CFDs, you are only required to deposit a small amount to enter the trade, known as margin. The broker sets the margin and gives you greater market exposure since the profits are calculated on the entire trade’s value and not just the initial deposit. 

For example, if you wish to trade an Index CFD called XYZ, which has a market price of $100, and the broker demands a 10% margin, you can enter a trade by depositing only 10% of $100, $10. Now, suppose the market price of XYZ Index CFD increases to $140; this gives you a profit of $40 by only investing $10 - making it a total return of 4 times than the actual investment. 

How to calculate Index CFDs?

Each index begins at a value of 100 and gains more value with each passing trading day if there is a continued uptrend. The return on each CFD is calculated daily and the index return is calculated by averaging the daily returns of the CFD. 

On the next trading day, you can add the previous day’s returns to the new Index CFD’s value to find the current day’s returns on Index CFD. 

The three ways to calculate an Index CFD’s value are:

1. Price weighted method 

In the price-weighted method, you give more importance to the securities' price that makes an index instead of the market cap attached to these securities. More costly securities will have a higher weightage in your Index CFD calculation. You start by adding the individual share price of each company in the index and divide it by the total number of companies. 

2. Equal weighted method

In the equal-weighted method, every single stock in the index is provided with equal weight, irrespective of each company’s individual share price and market cap. The return on each stock is then summed and divided by the total returns, providing you with the value of the Index CFD. 

3. Market capitalization method

This method provides bigger companies in the index with a greater weightage than smaller ones. That’s because it is known that bigger companies make more money, hence give more profit to investors. Each stock in the Index CFD is given a particular value out of 100 based on its market capitalization, which is then multiplied by the index returns. The returns are then summed up to resemble the value of the Index CFD.

Benefits of Index CFD trading

Short the index: You can short an index by borrowing Index CFDs from the broker and selling them immediately at the prevailing market price. Then you can wait for the Index CFD price to go down, at which you can purchase back the CFDs and return them to the broker, keeping the difference made as a profit. 

Hedge your existing portfolio: Hedging means you open a position that goes against another currently open position. For instance, if you have a long position open for Apple but expect the prices to fall, you can hedge by opening a new short position simultaneously.

Trade with leverage: Index CFD allows you to take bigger market positions by investing only a part of the total investment value. This small investment deposit/value is known as margin and lets you make profits on the full investment size and not just the invested amount. 

Diversify your portfolio: When you trade an Index CFD, you open up your investment portfolio to an entire range of stocks belonging to a particular stock market. This enables you to diversify your portfolio in a cost-effective manner as you do not need to purchase individual stocks one by one 

Trade Index CFDs today with a minimum deposit for maximum gain

Index CFD trading helps traders access the indices of their choice at a lower cost and maximize their profit potential.

Start trading with Index CFDs on Blueberry today and enjoy tight spreads, transparent trade execution, and efficient monitoring.