Spread Betting the FTSE 100, DOW, S&P 500 Index and Russell 2000

Spread Betting the FTSE 100

It is often assumed that the best-known indices are a fair reflection of the wider stock market, but this is not necessarily the case. In any index you normally have 2 or 3 companies that are very important to the overall market. These handful of companies not only carry a high weighting in the index, but are also the most traded two companies.

To illustrate this point let's pick on one market index (FTSE 100), you will notice that it is comprised of 100 of the uk's top companies, which between them represent over 82% of the country. Anyone trading the FTSE has to be conscious of developments in the sector. A bid rumour, annual results, news of drugs trials and so on, can all have a disproportionate impact on the index. i.e., Vodafone being one of the major constituents are selling more phones than usual so you can hazard a guess at when they release their profit/loss accounts that the FTSE 100 will (if you do the homework right...) drive the market upwards due to better than average earnings. However, there's another 99 companies to watch out for and millions of people buying and selling shares all day that will have negative/positive effects on this value.

As the FTSE 100 is a weighted index which basically means the bigger the market cap of the company the more it moves the market (weight). Some leading companies to look out for in the FTSE 100 are (in order of market weight which = influence):

BP represents around 10% of the index.
HSBC represents around 7%.
Third and fourth are Glaxo and Vodafone weighing in around 5% each.

As you can see this is just the tip of the iceberg but for an example of consequence, if BP's share price moves just 3% (possible daily average) then the FTSE 100 would move 15 points.

So my advise for someone interested in spread betting on indices would be to start with these top 4 movers and then when they start to get a feel for these companies and can speculate on their movements with a little better than average success, then they can look at the others by weight first. This, in time will give you an indication of speculation on the FTSE 100.

Or failing that, do what most do and take a gamble on gut feeling or one piece of information . Be aware that most jump in and don't make it over a period of time, so, jumping head-on in index markets is not recommended.

Providers do not quote the 'Cash Price' but the 'Future'

It must always be remembered that you cannot actually 'buy' 'the FTSE'. You can buy a future or option for cash settlement on a future date but you can never actually buy the index.

For instance none of the spread betting providers quote the market price on the cash index. You have to be trading the FTSE future to get a correct price, usually there is a little bit more spread if you are trading via spread betting. The real exchange FTSE future price is usually 0.5-1.0 (plus commission). The important thing is, that the spread bet FTSE cash index reflect the movement of the underlying asset, not necessarily that the quoted price is the same as the index.

Let's take the case of a spread betting provider; Capital Spreads, Capital Spreads do not quote the 'cash' price (i.e a market that expires each day), they quote the rolling daily. The underlying instrument for the rolling daily is the FTSE future taken from LIFFE. The rolling daily is quoted a set difference from the Future and this is calculated from the 'cost of carry' plus and dividends which are due to go 'ex-div' between NOW and the expiry of the Future. This is commonly called the 'fair value'. Sometimes the fair value can move a little bit during a session but generally not more than a couple of points.

Capital Spreads (and nor does anyone else) quote from the FTSE index. This is because the cash index only updates once every 15 seconds (count it ...one.elephant.two.elephant.three.elephant.four...) in which time the future can have moved 15 or 20 points. If anyone quoted from the cash index they would be picked off all day long as traders watched the futures move and just bought or sold the cash in the knowledge that the price will move to take into account the LIFFE market.

Useful Exercise

This takes a little bit of time to do, but for those of us who have sharescope (or similar) it's fairly easy to do.

Set up 5 separate monitors each divided into 15 separate shares (the last one 25 shares) Select FTSE 100 shares by market cap size, so for example FTSE 15 is the 15 largest FT companies by market cap etc) FTSE 30 the next 15 et al.

If you do this, you will see that if both the banks and the miners are up it is almost impossible for the FTSE 100 to be down. The FTSE 100 is a weighted index with the top 10/15 accounting for more than 60% of movement.

Also, take the top 350 FT100/250 companies and divide them into stock market sectors, example banks, miners and oils, retail, land, builders, other financials.etc.

It will take an afternoon to do but once done is easy to maintain forever. ADVFN supports large numbers of multiple saved monitors and the data is stored on the ADVFN website, not your own computer.

This simple task enables you to look behind the market and see what is really happening. Today for example, the FTSE 100 is masking a more complex truth in so much as the FTS E250 (more representative of UK PLC is 1% down) many consumer related stocks are down.

Note that the Dow is a price-weighted index, not a market cap weighted index, and therefore the shares that move the index are XOM MMM and CAT.

Spread Betting the Dow Jones

I don't like spread betting the DOW for 2 reasons:

The Index only consists of 30 largest cap stocks, all huge mature businesses like IBM, Coca-Cola, American Express and Boeing; which doesn't reflect the market as a whole. Additionally the Dow Jones Industrial Average is price weighted with the main constituents presently being IBM, Caterpillar, Chevron, 3M and United Technologies, since they have the highest individual share prices.
DOW tends to have exaggerated moves against the intra-day/short-term trend, which is bad since it reluctantly follows the other Indices downwards, with dozens of anomalous spikes that can trigger your stops. I remember a time, when all my analysis told me the markets were headed downwards, and I placed a short trade on the DOW at a major technical resistance level with a stop 70 points above that (expecting a 200+ point downward move). A sudden spike hit my stop, during the market hours, and I was out of the trade. Subsequently, the DOW fell 320+ points after hitting my stop. I felt gutted. It was the second time I'd been right to call the market down, but my wide-stop had been triggered.
I decided to back test those 2 failed trades, by super-imposing the S&P 500 Index charts, and using the equivalent S&P entry prices and stops. Guess what I found? Both the trades would have been winners, as the spikes weren't as violent on the S&P, and didn't even come close to the equivalent stops.

The S&P 500 Index (which incorporates the top 500 quoted companies and weights them according to market cap) and Russell 2000 are better for trading the market as a whole, however the Russell has unfavourable out-of-hours spreads. The less well known Nasdaq Composite is also worth a look. Also, be aware of the market's average true range - for instance if you trade the S&P 500 do not expect to earn more than a few hundred points in a day by shorting the index.

Generally, I gauge overall market sentiment from Russell 2000 Charts, and I use the Nasdaq 100 to confirm/act upon any possible trend reversals, in the broader market. Be aware that the USA being the world's largest economy there is a strong 'feeling' (i.e. correlation) with the USA and UK meaning that the UK markets usually follow what the Dow Jones or S&P indices in the USA are doing. If the markets have been depressed within the US, you can expect the same sentiment to be reflected in the FTSE over at least the first few hours of trading the following day from within the UK markets.

On crazy selling days, I keep an eye on the VIX (Volatility index). If that spikes higher, I usually reduce my stakes to a quarter of the normal sizes, and I don't go against the prevailing intraday trend.

The markets run purely on speculation then settle down to the price they should be trading at. This is mostly true in most circumstances. In any market whether it's Coffee, Dow Jones Index, Gold...etc there will always be those who think the market is going up and those who think the market is going down - this is what makes a market - buyers and sellers.

Conclusion and Health Warning

Be aware of the possible trading ranges of the any instruments you plan to trade in. Indices, for example, frequently post three-digit moves - it may seem like easy money when your £5-a-point buy on the Dow makes you a nice £200 profit as the index ticks up by 40 points, but it's much less fun when a 200-point plunge leaves you facing a margin call of £1,000 on the same £5 bet.

Couple of pointers from personal experience - especially if you are just starting out - if spread betting the indices do consider setting a guaranteed stop but keep in mind that the indices can swing on a 1 minute candle say by as much as 50 points so if you trade an index and say set a 30 point stop you could be stopped out more or less instantly so you get the feeling you are losing quite often.

Starters - what are you going to trade? I suggest out-of-hours S&P 500 Index. It does not (well, sometimes it does ) move a great deal before the Wall Street opens. In most cases, however the S&P 500 Index moves in line with the European indices. You may think it too quiet but, once you get some practice with that, you'll have plenty of time and, hopefully, have made more money, to go ballistic with something more lively.

I became attracted to trading the indices because they are only two horse races. They go up or down. I have studied extensively the many 'systems' and the technical methods. All systems suffer one drawback; they are history. I like the indexes because of the volatility. Anyone who can predict the future is going to be rich. I can usually predict the market direction correctly. I have meticulous records. My problem is MYSELF. Failing to follow my own rules! Being too cautious and getting out too soon...etc

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