In Episode 8 of The Trader’s Handbook, we dive into the world of stock index trading, offering insights from Shaun Murison of IG Markets.
Learn why indices are an attractive option for traders, providing broad market exposure, lower risk compared to single stocks, and significant cost advantages. We discuss key concepts like leverage, liquidity, and how index trading can be more efficient for active traders due to lower barriers and 24-hour market access.
Beyond trading, Shaun highlights the use of indices for hedging strategies, helping long-term investors protect their portfolios in volatile markets. With practical tips on technical indicators such as RSI and stochastic oscillators, this episode provides a well-rounded look at trading strategies that can enhance your trading toolkit.
Listen to the episode below and enjoy the full transcript for reference purposes:
Transcript:
The Finance Ghost: Welcome to episode eight of The Trader’s Handbook, a really great series of podcasts that, as you probably guessed, are all about trading. If you’re only joining us now at episode eight, don’t worry, you’ll still learn some cool stuff today, but I certainly recommend that you go back and listen to the other seven episodes. There’s some really good stuff in there. And if you’ve been with us since the beginning, thank you and welcome to the latest show.
As you know, if you’ve been listening, we’ve spent quite a lot of time with Shaun Murison from IG Markets South Africa, just talking about the opportunities and risks that lie in trading stocks in particular. Stocks are very much my background, more investing in them than trading in them. and I’ve learnt some really fun stuff by playing around in my demo account, something that is highly, highly recommended.
I’m not really a forex or commodity person, but I know we’re going to cover them in shows to come and I certainly look forward to learning more about that. But something I am, is a stock index person, although historically I’ve done it through just buying exchange traded funds and getting broad market exposure, it’s very much that investment approach. But of course, these indices are also really helpful for trading. We felt it’s a pretty natural progression now to move from having talked about stocks for the past few shows into doing one on stock indices.
Essentially what an index is, is just a basket of stocks that follows a set of rules. Now, the rules may vary and there are a lot of different indices out there, but some of the big ones, some of the ones that you’ll certainly know offhand are things like the JSE All-Share index for local traders, that is the go-to that is obviously an index. The clue is in the name there. Things like the S&P 500, the Nasdaq 100, the Nikkei 225, all of these names that you see as tickers along the screen if you watch any of the financial media, TV shows or anything of the sort, those are stock indices. And these are a huge part of the market, Shaun. For traders, I would imagine this is probably even more of a focus than single stocks, isn’t it?
Shaun Murison: Indices, as you correctly mentioned, are a nice way of trading the market. It’s simply instead of picking one stock, which obviously has inherent risk, corporate risk etc. you group them together and you trade them as an index. I think there’s a natural progression for traders. A lot of people are introduced into the market, they start trading shares, they learn the mechanics of trading shares and then they start to progress to things like indices that can be a little bit more fast moving, but certainly holds a whole host of opportunities. Essentially what you’re doing is you’re taking a view on the success or failure of a group of shares rather than just one share. You’re diluting your risk, essentially.
The Finance Ghost: Absolutely, and that’s the reason why people like it from an investment perspective as well, right? You’re buying an ETF, you’re tracking an index, you’re getting a whole lot of exposure in one shot, which is quite nice. Obviously for traders it’s not that different. You’re getting that broad exposure. You’re not sitting with one stock that can go and release an announcement out of nowhere and suddenly move 20% or 30% or 40%. We’ve dealt with some of that in our risk management discussions on previous shows, how stocks can gap down, potentially gap past a stop loss if you don’t have a guaranteed stop loss in place, of course they can gap up as well and deliver you wonderful returns, but you can’t assume that that’s the direction of travel. Unfortunately, the shocks to the market are often on the way down. So in an index, you’re just not going to see those crazy moves unless there’s a cataclysmic global event. And even then, a huge correction will still take, you know, a few days. It’s not going to gap down 30% in a day, right?
Shaun Murison: I don’t want to say it’s never going to gap down 30% in a day because we haven’t seen that…
The Finance Ghost: Yeah, we won’t, we won’t tempt fate, right?
Shaun Murison: Very unlikely – I think the biggest moves we’ve seen on major indices, range between – actually recently we saw Asian markets really jumping higher on stimulus efforts there and we saw things like the Shanghai Composite, obviously representation of the Asian markets up 7% in a day or the Hang Seng index up 7% in a day. So outsized moves can happen, but they definitely seem less probable than if you’re looking at an individual equity. I just want to say, when you look at those groups of shares, quite often when you look at those indices, they are concentrated. So it might be, you know, if we’re trading in South Africa, we’d look at something like the top 40 index, the top 40 most liquid stocks on the JSE. But quite often you find that the top ten companies have the highest weighting and account for even more than 50%, which is the case on the JSE Top 40 index. You’ve got 10 shares there, I think with a cumulative weighting on that index sitting at about 53%.
The Finance Ghost: It is a fascinating thing to sort of add to your toolkit, right, is trading the index, not just trading the stocks. So let’s talk about some of the differences between the index versus the stocks. I mean, I would imagine it’s still a CFD, so nothing changes there. You’re still buying and selling to. Are there any other major differences that we should highlight here in terms of the actual mechanics of how the trading works versus shares?
Shaun Murison: Just to reiterate, a contract for difference could be on anything. It could be on a pencil! Obviously, here we’re looking at financial markets, so when you’re trading a share in CFD form, you’re trading a difference in price between your buy and your sell. You’re trading the index, you’re still trading it as a CFD with IG. It is the difference between the price that you buy for and then the price that you sell for. I think the difference there you’d look at when you’re trading a share, shares are priced in cents, and so it’s the difference in cents value when an index is priced in points. It’s a difference in points value. You just need to pick a contract size.
What does one point mean? Well, one point is in the value associated with it. So, you know, I just keep referencing our local market, the top 40 index, which is obviously a very popular product that we offer, and you could trade that contract at R2 a point or R10 a point or R50 a point per contract. If the index moves ten points in your favor and you’re trading at R10 a point, then you’ve made R100. Other things to consider is that generally with indices, like products like forex and commodities, they carry a higher degree of leverage. So again, just in the simplest of forms, leverage just how much your profits or losses are magnified in the market. To take a trade, you require a smaller deposit relative to the exposure or the value of your transaction within the market.
The Finance Ghost: Okay, that makes sense. It just makes it more efficient for traders, right? I mean, that’s the whole idea there.
Shaun Murison: Exactly. Easier to get it now and to magnify short term moves.
The Finance Ghost: And I think in some of our discussions historically, you mentioned to me that it is cheaper to trade the index than the underlying shares. Is that the case? And then what are the costs for a local index versus a global index? Is there any difference there?
Shaun Murison: When you’re looking at trading a share, you are looking at paying a commission in and a commission out. You’re going to pay a commission fee when you buy and when you sell. Now, shares will have an underlying market spread, which is another cost to consider in your trading, right? When you’re looking at shares, that’s not a cost that IG refers to their client or passes on to their client. It’s just something that’s naturally inherent in the market. When you’re trading indices with IG, the difference is you don’t pay a commission charge for your transactions. What you do is add points to the spread and those points are significantly cheaper than what you would pay when you’re trading a share. For example, if you’re trading a local share on the JSE, that commission fee would be 0.2% when you buy and then 0.2% when you sell. Then of course there’s that underlying market spread as well. If you’re trading the South Africa 40 index, it’s how we label it on our platform. IG’s cost on that to the client would be about six points either side. So twelve points, if you look at that as a percentage of what your total cost is, it’s like 0.015% as opposed to 0.2%. So, it’s considerably cheaper.
And when you start looking at global indices, the popular ones like the DAX (the Germany 40 index), or things like the Nasdaq, it’s all relative. And actually as a percentage of your exposure, those costs are actually even less because those are very, very highly liquid markets on an international front.
The Finance Ghost: Okay, that makes sense, I can see why traders like it. They get the benefit of lots of diversification. The costs are better and it’s more efficient in terms of leverage. All of this is actually good stuff. And I guess one of the other pros must surely be liquidity. I feel like there’s always someone on the other side of a trade on a broad market index. That’s not always the case on the smaller stocks. You can confirm that that’s the case, if possible? And then what other advantages are there here that we haven’t actually already touched on that would make people consider trading the index?
Shaun Murison: Extremely liquid, like you correctly said, a lot of volume going through on that, which makes it easier to get in and out of trades. Sometimes with a share, liquidity can dry up and so the price that you want to get out at might be a little bit less favourable. Also obviously fix things like your stop loss, reducing the sort of amount of slippage you might get if things did go unfavourably against you.
If you look at things like the higher leverage and reduced costs, it becomes more suitable if you’re an active day trader, obviously, because cost would be a barrier to making a profit.
IG also offers 24-hour markets on a lot of these indices, including the South African Top 40 Index. Underlying market hours based off the futures exchange for that Top 40 Index would be 08:30 to 05:30 but we offer a 24-hours market. Once it moves outside of that, it correlates to what’s happening in international markets. You can trade that pretty much 24 hours a day, five days a week.
Just to add to that as well, we keep talking about the speculative side of trading, looking to make short-term profit. But there are other uses for things like an index. So, for example, if you had a long-term investment portfolio and a number of different shares in there, and you’re worried about the market starting to come off, it could be quite costly for you to exit your position in the market. All those positions, you think, okay, well the market might come down, I might close all those shares, you’re going to incur all those commission charges and all those costs. Another way to view it is you could do something like take a short position on the Top 40 index because it’s a representation of a number of those shares, those liquid shares on an underlying market.
You could take a short position. Remember, a short position, taking a trade with a view expecting the market to fall, maybe in the short-term. And so if the market was to fall, you would generate a profit on your index position, which would offset the losses on your equity position. It can be used as a hedging tool as well, not just as a speculative tool.
The Finance Ghost: Yeah, very nice. Many, many ways to do things in the markets. That’s of course, what makes it so fascinating and why we all love it so much. Of course, nothing can be all good, surely. There’s got to be some cons to trading an index. Obviously, the one that jumps out at me just comes from my background as a more fundamental investor, I want to go and read a management narrative and go and look at a balance sheet and go and look at their margins. And of course, when you’re doing an index, you’re doing that for 40 stocks, you’re not actually looking at those details at all. You’re really looking at a macro view.
I guess you’ve got to be careful with some of the underlying constituents. The South African index would be quite mining heavy, for example, whereas in the US it’s very tech heavy. You still need to know what’s in there. There’s still research required, but it’s definitely a different kind of research. I don’t think you’re going and reading an earnings transcript too often to make a decision about an index. So that would be the one thing that jumps out at me. But I don’t even know if that’s a con, really. It’s just the nature of the beast. Are there any genuine cons around trading indices?
Shaun Murison: When you’re trading an index, I think it comes back to leverage. I think I’ve said it before on the earlier podcast, with great leverage comes great responsibility. Because your losses can be magnified more and because the index is leveraged more, it is something to consider. But I think if a person’s responsible about and fully understands that side of things, I think they can mitigate that risk. Now, coming to what you’re saying about the companies, they still have an effect on the index, so you can still do your deep research on those top ten companies. It’s actually quite a strong banking weighting after the elections this year, we saw quite a strong move on the banking side. When you start looking, you could do some sort of sectorial analysis as well on that, at the moment you’re looking at, I think it’s about 25% weighting of banks in the index, and then basic resources probably sitting about 20% weighting there. There is a case to be made that you can use some of the conventional deep dive stuff that you do from your fundamental background, but yeah, going back to the risk question, I think the leveraged traders need to understand leverage, but I think that applies across the board, whether you’re trading forex commodities, shares or indices, because high risk, high reward leverage is really something to consider and to be aware of if you want to manage your trading risk.
The Finance Ghost: So one last question, just around the indices, in terms of the strategies that people might use with them, I would imagine that day traders, this is probably their jam, right? Doing the index trading because of the liquidity, because of the costs and the efficiency and that kind of thing. I don’t think you can day trade stocks very easily. Maybe the very liquid stuff, sure. But would it be a fair assumption that this is where your day traders, your scalpers will kind of play?
Shaun Murison: Yeah, because that barrier towards making a profit is reduced from your cost, this is definitely a product that is suitable. People do still day trade shares. It’s not something that’s not done because sometimes you’ll get a huge movement on a share. You’re balancing off leverage. So shares might not be leveraged as much, but you know, obviously sometimes you can get bigger movements on shares, so they can actually be a little bit more volatile. When we talk about volatility, we talk about that range of price movement. But indices are quite interesting if you’re looking at just broad macro news. The scalpers might look at general news during the course of the day, they look for big news events, whether it’s around interest rates, growth, inflation, things like that. Look at when those news items are coming out, looking at what the expectation is, when that news is coming out, expecting a movement on the index because it’s a representation of the economy, essentially.
Nice product to trade when you’re trading news, which does obviously lend itself to day trading, but not exclusively to day trading. Obviously, we have uses like the hedging which we talked about as well, and you can take a longer-term view on that as well, but certainly a lot of appetite for the very short-term trading using indices.
The Finance Ghost: Perfect. I think let’s move on to that part of the show now where we deal with some technical indicators. This is the approach we’ve taken in the past few shows where right at the end we deal with some techs, just because it’s a lot to kind of take in and try to deal with as an entire show.
As always, I’ll include a chart in the show notes. I’ll go and have a look at the IG Markets Academy to go and see what great stuff you’ve got on this topic and maybe pull something from there to refer our listeners to.
We’ve covered trend lines in the past couple of shows. We’ve done support and resistance lines, and this is really important stuff. This really helps you see points on the chart where things might change direction or continue where they were headed, for that matter. And both of those things are really useful pieces of information. Now, something else that is very helpful is trying to understand whether a chart is overbought or oversold. That, I suppose, indicates whether or not things might change direction. Given if it’s overbought, then it may well start to turn lower. And if it’s oversold, it may start to turn higher. Who knows? But, you know, you try and use all these indicators to form a view. I think if you could just give us an overview of this approach and the value of doing it, and then, of course, some of the mechanisms that you actually use in making this assessment of whether something is overbought or oversold.
Shaun Murison: Okay, great. I think let’s just define overbought and oversold first. When you talk about oversold conditions, suggesting that a market, a share or whatever financial assets it is, has fallen and maybe it’s fallen a little bit too much – maybe that decline is reaching a short-term end and we could see a rebound in price. Then that’s oversold. Overbought would be the opposite. Maybe we’ve seen quite a strong rally and the price is looking a little bit overextended, I think that rally could be coming to an end and possibly changing direction.
Now, there are a number of technical indicators that you can use that are available, obviously, on the IG platform. They can assist with assessing overbought and oversold conditions, seen as a short-term indicator. And those are indicators which include, I think the popular ones are stochastic and the RSR, referred to as the Relative Strength index, or RSI for short. All the traders out there and the guys that are new to technical analysis, I think you can combine this type of indicator with some of the stuff we’ve talked about before.
We’ve talked about trends in the market. Markets don’t generally move in a straight line. If the market’s in an uptrend, you might wait for a bit of a pullback, you don’t want to buy at the top, you want to wait for the first little bit of weakness to join that longer term trend and oversold signal marks give us an indication maybe now that that short-term dip is over and we can continue to rally. Likewise, in a downtrend, if we see markets trending lower, it’s looking a little bit oversold and we might expect a bit of a bounce. And then when it gets to overbought conditions, we might say, okay, well, that bounce has ended. Maybe that’s an opportunity to sell into the market or to take a short position. It’s a nice indication that you can add other forms of technical analysis.
The Finance Ghost: And again, this is stuff that you can just draw on a chart on the IG platform. This is an option available to you as a technical indicator?
Shaun Murison: Yeah. All these indicators are available to you on the chart on the mobile device, on the online platform.
The Finance Ghost: Fantastic. There is a really good article on the IG website around the stochastics and the RSI and all this kind of thing. I’ll obviously make sure that I include that in the show notes. And I really do encourage people to just go and read up about it and also go check out the stuff we’ve talked about previously, the trend lines, the support and resistance lines. The stuff really does make a significant difference.
Shaun, last question from my side, maybe just taking us back to indices and to close there, is it the case that most South African traders, or at least that the most popular among South African traders would be the All-Share index? Do you kind of see that familiarity bias coming through where people want to focus on that, rather than stuff very far away? S&P, Nasdaq, Nikkei, whatever the case may be, do our local traders tend to lift their gaze to all of the international opportunities available to them?
Shaun Murison: I think, like I was saying earlier on, there’s a bit of a journey. We have traders come in, they usually start with shares and then they progress to indices. That appetite seems to be quite strong. From the local account where you can trade that Top 40 index, a vast majority of trades go through on the index rather than shares. I think it’s more than 60%. I don’t have the exact figure for you. And then we do have a split. The range of products that guys trade offshore is generally currencies, indices, and some commodities, popular commodities, things like gold and oil.
The Finance Ghost: Shaun, thank you so very much for your time again this week, and lots and lots of good stuff still to come in the series. We will, as you’ve talked to that, get to some of the other asset classes like forex, like commodities, etc. There’s still lots of technical stuff to talk about and to the listeners, I think send through ideas of what you want us to talk about. We would love to respond to the burning questions you have. You can reach out to us on the socials or whatever the case may be, and we’ll certainly make sure that we try and cover some of that. And Shaun, to you, thanks for your time. I’m sure the Chinese stimulus has caused lots and lots of activity among the trading community in the IG Markets community, so they must be keeping you pretty busy out there in China.
Thanks for your time and I look forward to doing the next one with you.
Shaun Murison: Awesome. Thanks very much.
The Finance Ghost: Thank you.
