When thinking about spreading your capital over different asset classes and financial products, you’re working on your asset allocation, an essential part of any successful investment process.
Depending on your risk tolerance, strategy, financial goals, investment capital, and time horizon, you’ll select different assets to create a well-diversified portfolio that will help you minimize your risks while maximizing your potential profits. Your age, your professional and personal life, as well as your financial situation, are also important factors to consider when thinking about your ideal asset allocation.
Usually, stocks, bonds, commodities, cash, and real estate are the most popular asset classes to invest in. But more and more often, investors and traders are getting involved in cash indices or Cash Index Trading for the short term, and ETF investment over the longer term. Let’s have a look at what cash index trading is, why you might want to consider them for your strategy, as well as the best ways to trade them.
What is Cash Index Trading?
Cash index trading are Indices on the stock markets that are tracking the performance of a group of individual stocks, securities, or assets, which allow traders and investors to get exposure over a specific geographical area. Such indices would be the Australian ASX, the United States with the Dow Jones, S&P 500 and the Nasdaq, China with the CSI 300, Europe with the Euro Stoxx 50, the United Kingdom with the FTSE 100, etc.
Cash indices can also refer to a specific market sector – indices in the healthcare, energy, consumer products, financials, industrials, and utility sectors, among others.
The most common ways for indices to be computed are price-weighted and market-capitalization-weighted. The first method involves adding the prices of all the components and dividing them by a divisor to weigh each component based on their share price. Therefore, the companies with higher stock prices have a greater impact on the performance of the index. The second method involves determining the weight of each component of the index based on its market capitalization, which often favors the largest stocks.
Another difference regarding indices is that they can be traded on the cash market and on the futures market. Cash indices are traded on the spot, which means that the indices are traded for immediate delivery, with prices based on the actual prices of the underlying asset. Indices futures are financial contracts agreed between two parties to exchange indices at a specific price and at a specific date in the future. Their values, therefore, depend on the evolution of the expected future value of the given indices.
What are the advantages of cash indices?
Increasing the proportion of cash indices in your investing strategy can help you diversify your portfolio more effectively since they provide you with exposure to many firms operating in a variety of activity sectors. And because each industry reacts differently within the current economic cycle and has different future growth prospects, your losses in one industry could be offset by profits in another one.
Another advantage of investing in cash indices is that you invest in a basket of stocks, which means that you do not have to conduct a thorough research about individual companies to pick the right company to invest in. Moreover, transaction costs associated with cash index trading are usually lower than trading individual stocks.
You’ll be able to trade cash indices in most of the well-popular and regulated brokers, which means that they are easily available and highly liquid. It will therefore be easy for you to add them to your strategy and buy and sell indices at the right price, without having to significantly affect the underlying asset’s price.
Finally, cash indices include publicly traded companies and are provided by worldwide regulated stock exchanges, which means that you can quickly find reliable information online to help you decide whether the index is going up or down.
Bottom line
Now that you’ve understood the relevance of adding cash indices to your asset allocation, you need to decide the best ways to integrate cash indices into your investment or trading strategy, depending on your trader/investor’s profile. Usually, active and aggressive traders, such as intra-day traders, will use leveraged derivatives like CFD, Turbos, and Warrants on cash indices, while longer-term investors will usually use ETFs on cash indices or similar funds.