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What is a stock market index?

The stock market we know today is nothing like it used to be when the concept was born. Hundreds of years ago, the stock market started as a small institution created by agricultural traders and banks of Europe to manage and regulate commodity trading. Fast forward to the 21st century, it has transformed into a comprehensive global network of stock exchanges. The modern stock market, also called the share or equity market, offers various financial instruments (securities) on dozens of exchanges worldwide – stocks, shares, bonds, mutual funds and others. When a number of such securities are put together, it's called a stock index. In this article, we'll take a closer look at stock market indices, explain how they work and the benefits of index trading <h2>What is a stock market index?</h2> A stock index is a basket of various financial instruments. However, most indices that are available for public trading typically include only companies' shares. These companies have to be publicly listed on a stock exchange, meaning their shares can be bought, sold and owned by the public. There are different ways of organising these companies into stock indices – they can be grouped by financial market, country, industry or another differentiator. This allows analysts to track and measure the performance of the category they belong to and calculate market performance. For example, if an index value of the US major companies is going up in value, it usually means that the country's economy is expanding. <h2>What is an index ticker?</h2> An index ticker, also called a symbol or code, is a combination of letters and numbers used for the index's easy identification and tracking. Just like each currency has a code in the forex market – EUR for the euro, USD for the US dollar and so on, indices also have their own code. For example, S&P 500 stands for The Standard and Poor's 500 index. The term ticker is not exclusive to stock indices and used in other markets, such as stocks, futures and ETFs, too. Keep in mind that brokers usually use different tickers to distinguish instruments used to trade indices. For example, with ThinkMarkets, you can trade indices with CFDs, so to differentiate the actual S&P 500 index from a CFD contract on it, the latter has the SPX 500 ticker. <img alt="TM-Screen-What-is-a-stock-index-1.png" src="/getmedia/a5189b4f-bfff-48cf-b265-c184ed7acada/TM-Screen-What-is-a-stock-index-1.png" title="TM-Screen-What-is-a-stock-index-1.png" /> <h2>What are the most popular indices in the stock market?</h2> The popularity of a stock index depends on where the companies within it originate. For example, with the US being the largest economy in the world, American stock indices make up over 50% of the value of the global stock market. It is no surprise that these indices are the most popular and the most traded in the world, with S&P 500, Nasdaq 100 and Dow Jones usually leading this list. <img alt="01-map-1.png" src="/getmedia/3f976ffd-1a3e-4015-98e0-a1c5a6f1d6ea/01-map-1.png" title="01-map-1.png" /> <h3>S&P 500 (SPX 500)</h3> The S&P 500 is a stock market index that tracks the performance of the 500 largest companies in the US. It is considered the benchmark of the American economy because the aggregated value of the companies within it represents over two-thirds of the US stock market’s value. <h3>Dow Jones Industrial Average (US 30)</h3> The Dow Jones Industrial Average index is very similar to the S&P 500 but tracks only the 30 largest companies. Due to their similarity, these two stock indices are highly correlated and tend to move in the same direction. <h3>Nasdaq 100 (NAS 100)</h3> The Nasdaq 100 index consists of the 100 largest non-financial companies' stocks. The companies that make up this stock index represent various industries, but due to the dominance of major technology sector players, NAS 100 is tech-heavy. Other popular indices usually track the performance of large economies, such as the total market index of the UK – FTSE 100 (UK 100), Japan – Nikkei 225 (JPN 225), Germany – DAX 40 (GER 40), and others. <h2>Why is index trading popular?</h2> Index trading attracts a fair share of retail traders looking for personal gain. Here is why it's so appealing to them: <h3>Diversification</h3> Due to their nature, indices provide traders with greater exposure than any other financial market, limiting risk at the same time, as they are less likely to be affected by a sharp move from a single stock. <h3>Comfortable volatility levels and consistent trends</h3> Broad diversification results in more consistent trends and much milder volatility that rarely sees enormous price jumps, which can be very appealing for risk-averse traders. <h3>Reliability</h3> The stock market is well established. It's been around for a couple of centuries and has had enough time to set clear rules and regulations. Stock exchanges around the world are managed by reputable and trustworthy institutions that would crack down on fraud or price manipulation. <h2>How are indices made?</h2> The list of companies that make up a specific stock index is not permanent. Every index has a set of criteria a company needs to meet to be included in a certain stock index. The requirements may vary from index to index, but market capitalisation and liquidity thresholds are usually among the most common ones. As market conditions change and economies evolve, some companies may fall out of an index while others may become a better fit for it. The eligibility requirements also depend on the index's type. For example, indices that are weighted by company value may have very different prerequisites compared to indices weighted by stock prices. In our next article, <a href="/uk/trading-academy/indices/stock-market-indices">Stock market indices: all the types you need to know</a>, we explore different types of indices and explain how they can be calculated.

10 min readBeginners

Indices

Stock market indices: all the types you need to know

Traders just getting into stock market indices may notice a lot of different terms used to define them, such as small cap, equal weighted, growth index and many others. All these names are used to define what types of stocks make up an index to facilitate market analysis for traders. In this article, we’ll help you outline the main types of indices and their differences. Let's start with one of the most common ways to categorise indices – by the weight of stocks within them. <img alt="" src="/getmedia/6ade89c8-1b01-4102-8d86-e205dff6a416/article-indeces-types-all.webp" /> <h2>Weighted indices</h2>   There are three types of indices by weight: <h3>Market capitalisation-weighted indices</h3> A company's market capitalisation means its value on a market. It can be calculated by multiplying the total number of outstanding shares (all the shares it has ever issued) by the share price. For example, if company A has 100,000 shares priced at USD 20, its market cap is:   100,000 X 20 = USD 2,000,000   If an index is weighted by market cap, it means that the companies with a higher market capitalisation or value are given more weight. Simply put, higher valued companies have more importance in a market cap-weighted index. For example, if the index value is USD 500 million, a company worth USD 100 million will make up 20% of the index value. Price movements of this company have more effect on the index than a company with a USD 10 million market cap. <img alt="" src="/getmedia/05c99dd9-460d-494a-94d5-9806c49b8c66/article-indeces-types-market-cap-weight.webp" /> Market cap indices are the most common because they provide a clear and accurate way of evaluating stocks within an index. It also makes the performance analysis of an index much easier, as it is based on stocks’ true value. Almost all the top-traded indices we discussed in our previous <a href="/uk/trading-academy/stocks/what-are-stocks">What is a stock index</a> article are weighted by their market cap – S&P 500 (SPX 500), Nasdaq 100 (NAS 100), FTSE 100 (UK 100), DAX 40 (GER 40) and Nikkei 225 (JPN 225). However, most of these indices list stocks by free-float market capitalisation. It means that the company’s market cap is calculated by taking into consideration only the publicly held shares, ignoring the privately owned ones. <h3>Price-weighted indices</h3> The companies within price-weighted indices are given weight according to their current share price. The most expensive shares will have more importance compared to the lower-priced ones. For example, a company with a share price of USD 1,000 will have a much stronger effect on the index performance when its price fluctuates compared to a company with USD 100 shares. The Dow Jones (US 30) index is one of the most popular examples of a price-weighted index. <img alt="" src="/getmedia/b34fc161-34a4-4156-b9a1-74397245b666/article-indeces-types-price-weight.webp" /> Price-weighted indices are less common than market cap ones because stock prices are not always an accurate indication of their true value. <h3>Equal-weighted indices</h3> This way of calculating indices is the most intuitive – each company carries equal weight, value and importance, regardless of the company's size. Simply put, in an index made up of 100 companies, each company represents only 1% of the overall index's price. <img alt="" src="/getmedia/8d4a5809-05db-4b49-b5fa-af0c38918e1a/article-indeces-types-equal-weight.webp" /> Equal-weighted indices are quite popular among traders because they don't depend on the largest stocks as much as the market cap indices, which reduces the risk for traders. Keep in mind that some indices can have several variations. For example, the S&P 500 is commonly used as a market capitalisation-weighted index, but there is also a lesser known, equally weighted version. This equal-weighted S&P 500 is tracked under a different ticker and has the same list of companies, but they are given a fixed weight. <h2>Market capitalisation indices</h2>   The market-cap indices can be further divided into three smaller groups:   <ul> <li>Large cap indices – over USD 10 billion</li> <li>Mid cap indices – USD 2 – 10 billion</li> <li>Small cap indices – USD 300 million – 2 billion</li> </ul>   This method of index classification is also very popular among traders as it gives an immediate indication of the index’s nature. You’ll often see it in the name of the index right away, for example, Russel Mid Cap 2000 index (US 2000). If you don’t see any indication, it implies that the index is a large cap, like all the most popular indices we’ve mentioned above. <h2>Indices by geographical affiliation</h2>   On a wider scale, indices are usually divided by the geographical location of the companies included in them.   <ul> <li>Global (worldwide) indices track stocks from all over the world. For example, the MSCI world index consists of stocks from 23 countries.</li> <li>Regional indices consist of stocks of a particular region. The Euro Stoxx 50 index (ESTX 50), composed of 50 blue-chip companies from 11 countries of the Eurozone, is one good example of a regional index.</li> </ul>   It's worth mentioning that there are indices that are somewhat similar to regional, but they combine stocks from various locations based on the economic advancement of their country of origin – developed or emerging.   <ul> <li>National indices are made up of stocks of the same country. These indices are the most popular and heavily traded because their performance is correlated with their respective country’s economic growth, making it easier to evaluate and identify trading opportunities. That’s where the top-traded indices from our list belong, among many others.</li> </ul> National indices, along with the sectoral ones, are often used as a benchmark – a standard to measure the performance of other indices against, as they usually include the best-performing stocks of their category.   <h2>Sectoral indices</h2>   This classification is popular among traders because companies that belong to the same economic sector are usually influenced by the same factors and perform similarly, making the analysis easier. According to the Global Industry Classification Standard, there are 11 official stock market sectors:   <ul> <li>Financials</li> <li>Healthcare</li> <li>Energy</li> <li>Materials</li> <li>Utilities</li> <li>Industrials</li> <li>Real estate</li> <li>Consumer discretionary</li> <li>Consumer staples</li> <li>Information technology</li> <li>Communication services</li> </ul>   <h2>Indices by stock types</h2>   <ul> <li>Value indices are made of stocks that tend to preserve value, combined with slow but steady growth, resulting in very low volatility. Due to reduced trading opportunities, these indices are rarely of any interest among day traders. However, they are often appreciated by long-term investors.</li> </ul>   <ul> <li>Growth indices consist of companies with above average sales growth and may experience periods of high volatility. The most traded stocks usually belong to this category.</li> </ul> <h2>Islamic indices</h2>   Besides the outlined common types of indices, analysts often segregate Islamic indices into a separate category. These indices can be further categorised following the same logic as other indices, but they only include stocks of the companies that comply with Sharia law. However, due to some limitations and controversies, these indices are more popular among long-term investors than active traders. It's important to check some basic information about an index before you start trading it, as it can help you evaluate future price movements and identify trading opportunities. In market cap and price-weighted indices, for example, you'll need to pay closer attention to factors affecting the largest and most expensive stocks as they affect the overall price of the index. On the other hand, equal-weighted indices are more sensitive to factors affecting their overall performance. National indices will heavily depend on the economy of the country they belong to, sectoral on a sector and so on. Now let's see <a href="/uk/trading-academy/indices/what-affects-stock-index-prices">what can affect stock market indices' price movements.</a>

4 min readBeginners

Indices

What affects a stock index price?

Understanding what moves the stock index prices is crucial for a successful trading strategy. Knowing the bigger picture can help you make an informed decision and identify the right time to place a buy or sell order instead of trying to predict price movements sporadically. It is true that the past performance of any financial instruments, indices included, doesn't always serve as a good indication of their future movements. It's important to look at other factors that drive stock index prices up or down to identify trading opportunities. These factors can be divided into two groups: those that influence individual stock prices within an index and those that drive an index as a whole. <h2>Factors influencing individual stocks within an index</h2> <img alt="" src="/getmedia/6e2a8dba-8d06-44c2-bb37-e28461ba1b05/article-what-affects-stock-index-prices-individual.webp" /> The first group is particularly important for indices <a href="/uk/trading-academy/indices/stock-market-indices">weighted by market cap or stock price</a>, as their price can be significantly affected by the top-performing stocks. For example, tech giants like Apple, Microsoft, Amazon, Google (Alphabet) and Meta make up almost 40% of the Nasdaq 100 (NAS 100) index, each accounting for 3-11% weight of the index. If any of these companies experience significant changes in their stock price, it will affect the price of NAS 100 to a much greater extent than a company holding only 0.2% weight of the index. To evaluate the possible price fluctuations of top performance in an index, experienced traders usually identify them first and then look for the following information: <h3>Company earning reports</h3> Bigger than expected profits are likely to drive the stock (and index) price up, while unexpected losses can have the opposite effect. Earnings reports are usually released quarterly and published during the first month of the following quarter. <h3>Announcement of dividends</h3> Some traders are hunting for dividends, buying shares shortly before the dividend announcement, also called the ex-dividend date. This drives the demand up, increasing the stock price as a result. After the dividend pay-out day, they sell their shares, which causes an immediate drop in their price. As most companies pay dividends quarterly or semiannually, it is worth keeping an eye on these releases to catch index trading opportunities. <h3>Management restructure</h3> A CEO or any other key role replacement can have a big impact on the stock price, affecting the entire index price. The direction of the price movement usually depends on market sentiment. If traders see the successor as competent, it can increase the stock price and vice versa. <h3>Positive company news</h3> Announcements of a new product launch or expansion usually indicate a company’s solid growth plan, which can drive its share price up, increasing the index price consequently. However, this factor largely depends on market sentiment as well. <h3>Alleged controversies</h3> A company's involvement in controversial reports usually affects its reputation negatively, thereby affecting its share price and bringing the index price down. In some cases, damage can be caused not only by a company’s reputation but by the reputation of its leader as well. For example, Elon Musk, the co-founder and CEO of Tesla, brought price swings to the company’s shares with his publicity stunts more than once. <h2>Factors that affect a stock index price as a whole</h2> <img alt="" src="/getmedia/3bd1a15f-eac2-4a6c-a7c3-02f2ce066815/article-what-affects-stock-index-prices-whole.webp" /> This group of factors usually has a much stronger impact on an index price than factors affecting individual stocks. They can be divided into three sub-groups: economic data, political events and natural calamities. When analysing these factors, traders need to keep in mind the origin of the index and the companies listed within it. For example, the US data and events are the most influential for American indices, such as S&P 500, Dow Jones, and Nasdaq 100. On the other hand, for the Euro Stoxx 50 index, which includes stocks from 11 countries within the Eurozone, traders need to keep an eye on data from the countries of origin of the top-performing stocks. <h3>Economic data</h3> Indicators such as interest rates, inflation and Gross Domestic Product (GDP) are among the main factors affecting index prices. As many indices are grouped by industry or country, significant changes in the mentioned numbers usually hit the whole index. For example, if the inflation rate in the US increases, it will negatively impact the whole US stock market, bringing down the prices of all major indices in a ripple effect. In the opposite scenario, a strong USD usually has a positive effect on them. Increasing interest rates can have a similar effect on index prices, making business loans much more costly for companies, which, in turn, slows down their development, bringing stock prices down. On the other hand, a rising GDP signals a strengthening economy and can positively impact an index, driving its price up. Keep in mind that all economic processes are interlinked – an increasing GDP in the long term usually means increasing inflation, which means increasing interest rates to fight it and so on. Hence, economic indicators need to be analysed as an aggregate rather than on their own. An <a href="/uk/economic-calendar">economic calendar</a> is a great tool that helps traders have all the worldwide data releases in one place. <h3>Political events</h3> Political instability within a country tends to influence the country’s stock market indices negatively. Weak government, protests, and controversial policies can cause a visible decline in index prices. Elections can bring a lot of volatility to the index price too, but this volatility is primarily caused by public sentiment, reacting to election promises given by winning candidates. Some large-scale political events have a strong negative influence not only on the countries involved but also on the global economy. At the end of June 2016, when the UK voted in favour of leaving the EU, and it became clear that Brexit was, in fact, happening, over USD 2 trillion was wiped out from the global stock market in a single day. Another example is the Russian invasion of Ukraine. The war disrupted the supply chains of many commodities that used to be supplied by both Ukraine and Russia, affecting the global stock market. Moreover, sanctions aiming to paralyse the Russian economy affected multiple economic sectors, causing an almost 10% plunge in the global stock market during the first week of the war. However, as the NATO alliance showed strong support for Ukraine, the stock market bounced back. <h3>Natural factors</h3> Natural disasters, such as tsunamis, floods, wildfires, and public health emergencies, like the infamous COVID-19 pandemic, can bring not only serious physical damage but economic damage as well. These events interrupt the production and distribution of goods and services, affecting global markets and bringing the prices of stock indices down. COVID alone, for example, sent the stock market into a free fall, causing the sixth-worst percentage price drop in history. However, in the long run, the pandemic has benefitted the tech industry, and tech-heavy indices have had significant growth which is reflected in their prices. Traders looking for index trading opportunities need to pay close attention to the news covering important events. However, this data can only indicate possible price movements, not a 100% accurate prediction. To create a holistic trading plan, it’s important to evaluate several factors consecutively and draw an informed conclusion. Moreover, market sentiment or public perception can often influence index prices more than anything else. Unfortunately, since it’s a subjective matter, it cannot be predicted in advance, but some traders use technical analysis to spot price movements caused by market sentiment. We’ll discuss technical analysis in one of our following articles. For now, let’s first see how you can trade indices with the information we have covered in this article. The good news is that when you trade indices with CFDs, you can capitalise on both rising and falling prices. Check out our <a href="/uk/trading-academy/indices/how-to-trade-indices">How to trade indices</a> article to see how it works.

3 min readBeginners

Indices

How to trade indices

Unlike many other financial markets, stock indices don't provide an option for their physical exchange. It is simply not feasible as indices are made of dozens and hundreds of stocks. It also means that direct investment in indices is not possible – you can't buy them like shares. However, there are various financial instruments that mirror the performance of indices and can be traded and invested in. One good example of such financial instruments is derivatives. With ThinkMarkets, you can trade stock market indices with derivatives called contracts for difference – CFDs. There are two types of CFDs – contracts on the current price and contracts on index futures. It may seem a little complicated, but all you need to do in both cases is speculate on price movements. In the first case, it’s the movement of a current price and in the second, the movement of a future price. If your prediction is correct – your trade is successful, and if the price moves in the opposite direction of your prediction, your trade incurs a loss. If you are new to derivative trading, check out our <a href="/en/trading-academy/cfds/what-are-cfds">CFD trading: a beginner’s guide</a> where we explain what derivatives are and how CFD trading works in detail. Keep in mind that brokers usually use different tickers to distinguish instruments. For example, on ThinkMarkets’ trading platforms, S&P 500 is marked as SPX 500 for CFD trades on the current price and ESH3 for CFD trades on the futures contracts. <h2>How to trade indices with CFDs</h2> <h3>Going long</h3> Assume you were to place a trade on the SPX 500 index. The current price is USD 4,000.00, and you think it will go up. You open a long CFD position (buy), and the price goes up to USD 4,010.00. The USD 10 is your profit. If the price goes down to USD 3,990.00 instead, USD 10 is your loss. <img alt="" src="/getmedia/d4e439ef-1d47-4500-9a69-cd9515fb48bc/article-how-to-trade-indices-long.webp" /> <h3>Going short</h3> In the opposite scenario, your prediction says the price will go down, and you place a short CFD trade (sell). If the price goes down to USD 3,990.00, as you predicted, USD 10 is your profit. If it goes up to USD 4,010.00 instead, USD 10 becomes your loss. <img alt="" src="/getmedia/8eac9b34-5ae0-4486-853d-01343c1207ea/article-how-to-trade-indices-short.webp" /> As you can see, it’s pretty straightforward. Now, let’s see the difference between trading CFDs on the current prices of indices and CFDs on index futures. When you trade CFDs on the current price of a stock market index, it means your contract follows its real-time price, and you speculate on the current price as well. On the other hand, a CFD on the index futures contract means speculating on the index's price at a certain date in the future. In both cases, trading indices with CFDs gives you extended trading hours, unlike some other types of trading. There is a simple explanation: while stocks are listed on the exchanges with fixed and limited opening hours, CFDs are not listed anywhere. As they only track the index's price, it remains set at its closing price while the exchanges are closed, making it available for trading. Once the exchanges are open again, the price is adjusted. You can find more info on the trading hours on the contract specifications page. Whichever way of trading you choose, there are a few more terms you need to know to understand your index CFD trade better. <h3>Points and ticks</h3> The price movements in index trading are measured in points and ticks. A point refers to the smallest price movement on the left side of the decimal point. A tick, on the other hand, refers to the smallest price movement on the right side of it. The value of one point equals USD 1, and one tick is USD 0.01. This terminology is not exclusive to stock indices and applies to all financial markets except forex, which measures price movements in pips. However, the values of a point and a tick vary depending on the market. <img alt="" src="/getmedia/c850f30e-f907-4925-89f3-2c8a218d3ff7/article-how-to-trade-indices-ticks.webp" /> <h3>Spread</h3> A spread in index trading, just like in any other financial market, means the difference between the buy (bid) and sell (ask) price. For example, on the image below, you can see that a spread of SPX 500 is 0.4 or 40 cents. Essentially a spread is the cost of any trade. That’s exactly why any new trade a trader opens starts at a loss – the spread amount gets deducted automatically and needs to be covered first before making a profit if the trade is successful. <img alt="" src="/getmedia/1c0a768a-b4a9-4fe0-9008-3e83bc9292d7/article-how-to-trade-indices-spread.webp" /> Keep in mind that the placement of a decimal point is different in index trading and trading stocks. The same 40 cents spread in stock trading would be marked as 40.0. <h3>Lots</h3> A lot in trading represents a trade size, or in other words, the number of units of a financial instrument. This number is different for every financial market. In the stock market, one lot contains ten contracts or ten CFDs in our case. When you trade indices, there are usually minimum trade size requirements set by the broker. With ThinkMarkets, some indices can be traded only in full lots and some in mini lots – 0.1 of a full lot (1 CFD). You can find these details on the contract specifications page as well. <img alt="" src="/getmedia/3c1474ed-b4ef-404b-a3a0-96cb488a79c9/article-how-to-trade-indices-lots.webp" /> <h3>Leverage and margin</h3> Trading indices with CFDs implies using leverage. It means traders borrow funds from a broker to open positions exceeding their account balance. To allow the utilisation of their funds, brokers require a deposit, called a margin. We explain both concepts in detail in the <a href="/en/trading-academy/cfds/what-are-cfds">CFD trading: a beginner’s guide</a>, too. When you trade with leverage, you don't need to pay the full price to place a position, only the deposit (margin). The amount of the deposit depends on how big your leverage is – bigger leverage means a smaller deposit, and vice versa. The level of leverage varies depending on the market and instrument and is usually set by a broker for each specific stock market index. Let's see how leverage works in index trading on the same example, where we placed a CFD trade at USD 4,000.00. If you open this trade with 200:1 leverage, you only need to pay 1/200th of the full amount, or USD 20. <img alt="" src="/getmedia/098e2e5b-7756-417c-bed7-29873b1b1c8c/article-how-to-trade-indices-leverage.webp" /> That's the main benefit of trading indices with leverage – you can open a much bigger position with a smaller deposit. Your potential profit is also multiplied. However, if you incur a loss, it does get multiplied too. That's why it's crucial to use <a href="/en/trading-academy/cfds/risk-management-tools-in-cfd-trading">risk management tools</a> like stop loss and take profit. Understanding this basic information is crucial to a successful index trading journey. Once you are confident with fundamentals, you can move on to creating a sophisticated trading strategy. However, it is highly advisable to practise on a demo account first before trading with real money.

4 min readBeginners

Indices

How to Use the Relative Vigor Index in Trading

The Relative Vigor Index (RVI) is an indicator that calculates the power behind price movements. In essence, the RVI indicator attempts to gauge when the market will reverse from the current uptrend or a downtrend.    In this blog post we look at the key characteristics of the relative vigor index indicator, how it is calculated, as well as its strengths and weaknesses. Finally, we will be sharing advice on how to design a simple trading strategy based on the RVI indicator. <h2>The formula for RVI </h2> The RVI indicator is based on an idea that the price action has a tendency to close higher compared to the opening prices in an uptrend, and have lower closing prices than opening in a downtrend.    A formula to measure the RVI is as follows:   NUMERATOR =  a+(2×b)+(2×c)+d                                        6   DENOMINATOR = e+(2×f)+(2×g)+h                                          6 RVI = SMA of NUMERATOR for N periods         SMA of DENOMINATOR for N periods   Signal Line = RVI+(2×i)+(2×j)+k                                    6 Where: <ul> <li>a=Close−Open</li> <li>b=Close−Open One Bar Prior to a</li> <li>c=Close−Open One Bar Prior to b</li> <li>d=Close−Open One Bar Prior to c</li> <li>e=High−Low of Bar a</li> <li>f=High−Low of Bar b</li> <li>g=High−Low of Bar c</li> <li>h=High−Low of Bar d</li> <li>i=RVI Value One Bar Prior</li> <li>j=RVI Value One Bar Prior to i</li> <li>k=RVI Value One Bar Prior to j</li> <li>N=Minutes/Hours/Days/Weeks/Months</li> </ul>   As you can see from the formula the RVI also has a signal line that interacts with the indicator. Based on the crossovers and divergences between these two, we extract the trading signals.   As many other trading platforms, <a data-di-id="di-id-6e0d35b7-1d3b3793" href="/metatrader5">MetaTrader 5</a> has a built-in RVI indicator. You simply choose the indicator from a drop-down menu and it will show up automatically on your chart. The default setting is based on 10 periods, in addition to a green color for the RVI oscillator, and red for the signal line. <img alt="" src="/TMXWebsite/media/TMXWebsite/Image-1-Vigor-index.jpg" /> The RVI indicator fluctuates around the centre line and it travels from above to below zero, and vice versa. As you can see from the photo below, the values are rising as the price trades in a bullish environment and vice versa. The indicator is classified as a centered oscillator, since it oscillates around the center line rather than a banded oscillator. <img alt="" src="/TMXWebsite/media/TMXWebsite/Image-2-Vigor-Index.jpg" />   <h2>Strengths and weaknesses of RVI</h2> The RVI compares the asset’s closing price to a recent price range and generates values of the power behind price movements. The higher the values it generates, the stronger the trend should be. On the other hand, lower RVI values imply a calm and sideways market.      RVI generates values which sometimes trade near the extreme levels up and down. Similar to the <a data-di-id="di-id-e48f415c-dc5b1189" href="/trading-academy/forex/analysis/rsi-indicator">Relative Strength Index (RSI)</a> in these situations, the RVI signals that a change in the trend direction is probable, which is actually its greatest strength.    On the other hand, the key weakness associated with the RVI is that it is practically useless in the ranging markets, when the price action doesn’t move in a clear uptrend or downtrend. Hence, traders tend to usually consult the RVI when the price action trades in the uptrend or downtrend for a longer period of time, as they try to predict when the current trend will end.    <h2>Crossover and divergence</h2> As noted earlier, the RVI indicator interacts with the signal line, creating different types of signals. For instance, a trading signal is generated when the RVI moves above the signal line. This situation is called a bullish crossover and it indicates that the price action is likely to start moving upwards. The bearish crossover is the opposite of the bullish crossover i.e. the RVI crosses below the signal line.    On the other hand, the interaction between the RVI and the price action can produce a <a data-di-id="di-id-201c69d3-252d29a6" href="/trading-academy/forex/analysis/bullish-bearish-divergence">bullish and bearish divergence</a>. The former occurs when the RVI creates a higher low or a higher high, while the price action creates a new low. It signals that the price action is likely to start following the RVI higher.   The latter takes place in the opposite scenario - the price action is still trading in an uptrend, but the RVI has already started to come off the highs, which implies that the asset’s price will start following the RVI in moving lower.  <h2>How to trade the RVI </h2> There are many different trading strategies based on the RVI indicator, as it is the case with the RSI and other oscillators. The vast majority of those are centred around either crossovers or divergence.  Here we are sharing a very simple trading strategy that tends to mix these two scenarios - a crossover and divergence. This way we get two signals pointing to the same future development - a reversal. In a chart below, you see USD/CAD moving lower, below the most recent low. The RVI follows and creates a short-term low, trading extremely close to its minimum levels. Remember that the RVI should only be consulted in the trading markets. <img alt="" src="/TMXWebsite/media/TMXWebsite/Image-3-Vigor-index_1.jpg" />   The RVI then generates two bullish signals. First, the crossover occurs as the RVI indicator (the green line) moves above the signal line (the red line), signalling that the trend is likely to change from bearish to bullish.  Secondly, the price action creates a series of consecutive lower lows, a situation which is not confirmed by the RVI, which starting with a crossover continues to move higher. As we noted earlier, this situation is called a bullish divergence and it signals that the price action may start following the RVI higher soon.  At this point, two bullish signals convince us to open a trade and look for a reversal. We opened a long trade aiming to capitalise on the impending trend reversal as the sellers seemed to have run out of gas.   The entry should be placed once both the crossover and the divergence issue bullish signals. The stop loss is placed around 40 pips below, to allow for the price action to potentially create another short term low.  Take profit is determined by searching for a “magnet level” - an important price point that played an important role in the past. This can be either a <a data-di-id="di-id-9ff3eeec-f5d0272a" href="/trading-academy/forex/analysis/fibonacci-ratios">Fibonacci retracement/extension</a>, moving average, trend line etc. In this case, we use the previous swing low, which is now likely to act as a resistance.    Ultimately, the price action creates a sharp reversal, surging higher and hitting our take profit order in just two days. In this trade, we risked 40 pips to make around 80 pips, which translates to a 1:2 risk-reward.

6 min readExperienced

Indices Market events

What is de-dollarisation and which markets will it affect?

The United States of America and the US dollar have been a pillar of dominance for decades. However, internal problems such as infamous fiscal and monetary policies, plus external pressures from political and economic rivals have exposed the global superpower’s weaknesses. While the USD is still a major player in the forex market, calls for de-dollarisation are making investors anxious about the greenback’s fate. In this article, we’ll go through what de-dollarisation is, which markets could be affected, and what it means to traders. <h2>What is de-dollarisation? </h2>   De-dollarisation is a global movement by nations to limit the use of the US dollar as the global reserve currency and medium of exchange for international transactions. For example, crude oil exports from Saudi Arabia to China are priced in US dollars. For China to complete the transaction, they need to sell their national currency (Yuan) to purchase US dollars, placing selling pressure on the Chinese Yuan and increasing the value of the US dollar. The idea behind de-dollarisation is to remove the US dollar as the transaction currency of choice and instead deal directly in Chinese Yuan or Saudi Riyal. To determine the effects of de-dollarisation, we need to first look at the role of the USD in the global economy. This will also allow us to correctly identify the potential consequences of the dollar’s erosion due to the de-dollarisation movement. <h2>The role of USD in the global economy</h2>   The US dollar is considered the world’s reserve currency since 1944. A reserve currency is a foreign currency held by central banks worldwide and used for international transactions such as world trade and global investments. This means that most countries have large dollar reserves, making the US dollar an essential factor in a nation’s economy. The prominence of the US dollar in global reserves is significant; as of 2021, the dollar constituted approximately 59% of the world's allocated foreign exchange reserves, according to the International Monetary Fund (IMF). <img alt="" src="/getmedia/8e9952fd-b426-4698-b647-44e5e5584e9a/Market-Events_De-Dollarization_USD-as-invoicing-currency.webp" /> The US dollar is also the world’s most used invoicing currency. An invoicing currency is the currency used for international transactions. A country must first exchange its local currency for USD to trade with another country. As per our example above, if Japan wants to buy metals from Australia, it cannot use yen to pay. It must first exchange yen for the US dollar. The US dollar's dominance in international trade, particularly in transactions involving countries like Japan and Australia, is highlighted by its role in Australian exports. According to the Australian Bureau of Statistics, between 2015-16 and 2020-21, the proportion of Australian merchandise exports invoiced in US dollars (USD) increased by 6.3 percentage points to 87.8%, while those invoiced in Australian dollars (AUD) decreased to 9.9%. Also, according to Eurostat, in 2020, 48.1% of all goods and 79.95% of petroleum and petroleum-related products imported into the EU from non-member countries were invoiced in US dollars. <h2>How did the USD become the international reserve currency?</h2>   The US dollar hasn’t always been recognised as the global reserve currency. The Greek drachma, Roman denari, Venetian ducat, the Spanish silver dollar, and the UK pound sterling are some previously globally recognised currencies. The reason for these currencies being able to dominate during their time is because each empire’s currency dominated the world economy and culture at their respective time. When other countries or people traded with these empires, they often retained the profits they generated in the empire's currency rather than exchanging them. By the end of World War 2, the US was virtually unscathed, helping it become the world’s biggest economy - generating roughly 50% of the world's GDP. Even today, most of the world’s biggest firms are US-based, and they demand payment in US dollars. Only 4 out of the 20 biggest firms by market cap (in late 2023) were not from the USA. <img alt="" src="/getmedia/2c737168-ea20-4818-a757-d0cf39bcc07e/Market-Events_De-Dollarization_previous-global-currencies.webp" /> Source: <a href="https://www.whytes.ie" target="_blank">https://www.whytes.ie</a> But there are also more direct reasons why the US dollar is today’s main reserve currency. In 1944, with the global economy recovering from the war, 44 Allied nations met to create the Bretton Woods system. This agreement involved countries like the United States, Canada, Western European countries, Australia, and Japan. This required them to peg their currencies to the US dollar. For these countries to peg their currency to the US dollar they needed to hold USD, in order to be able to supply their local banks and users. The dollar itself was convertible into gold at USD 35 per troy ounce. This system, however, was not a traditional gold standard where all currencies were valued in gold, but rather a fixed exchange rate system with the dollar as a central reference. On August 15, 1971, US President Richard Nixon ended the dollar's convertibility into gold, marking a shift to fiat currencies, which are government-issued and not backed by physical commodities. This move prompted a gradual shift from fixed exchange rates to floating rates, where market forces determine the value of currencies. Despite these changes, the US dollar remained the world's primary reserve currency, maintaining its pivotal role in international finance and trade. <h2>Why are there calls for de-dollarisation?</h2>   The global movement for de-dollarisation is led mainly by world leaders and business figures who are alarmed by the power that the US holds over world trade. Even a single rate hike by the Federal Reserve can plunge the global markets into chaos, with other currencies also feeling the effect. Security concerns are also behind the de-dollarisation movement. Russia, for instance, has actively called out the US Treasury for weaponising the US dollar against non-allies. These statements come after the United States and over 30 allies and partners imposed heavy sanctions on Russia in response to its unprovoked invasion of Ukraine, squeezing Russia’s foreign exchange reserves. One notable organisation that has been making waves towards de-dollarisation is BRICS, an intergovernmental alliance between emerging superpowers Brazil, Russia, India, China, and South Africa. BRICS have entered into bilateral trade agreements with each other and their respective central banks to reduce their dollar reserves and rely more on local currencies. <img alt="" src="/getmedia/3b40d2d7-89e1-4820-a67f-e40c94047b00/Market-Events_De-Dollarization_flags.webp" /> For example, China and Brazil made headlines on 29 March 2023 when they announced that they would stop using the US dollar as an intermediary currency when trading. This could serve a massive blow to the US dollar as China is one of its biggest rivals for the global market share. At the same time, Brazil is the biggest economy in Latin America. Russia and India followed suit, using Russian rubles and Indian rupees in international trade. There are also talks of BRICS establishing a common currency to take over the USD as the global reserve currency. Historically speaking, there have been multiple attempts to replace the USD, but none has come close to success. There are a lot of challenges that BRICS, or any other organisation, will face before they can effectively replace the US dollar. <h2>What is the data telling us?</h2>   The global shift from the US dollar as the dominant reserve currency is a gradual process. In 1999, approximately 71% of international reserves were held in USD, which declined to about 59% by 2021. This trend indicates a gradual de-dollarisation, although the US dollar still plays a significant role in the global economy. Several factors are contributing to the continued dominance of the US dollar. One of the primary reasons is the prevalence of US firms in international markets, with many requiring payments in USD. Additionally, the depth and sophistication of the US financial markets, alongside robust commodity trading infrastructures, make the dollar a preferable option. Other significant currencies face challenges that hinder their potential as viable alternatives to the USD. For instance, China's currency, the Renminbi, is not fully convertible due to solid capital controls, and the currency itself is not free-floating. Moreover, doing business in China is hampered by legal, political, and language barriers. With Russia, due to its involvement in the Ukraine conflict, is notably ostracised from international financial systems. Whereas Brazil and South Africa, face high inflation and economic volatility, and are also unlikely candidates for reserve currency status. Japan's Yen, while a significant currency, is less appealing due to the heavy involvement of its central bank in the bond market, leading to days with minimal trading activity in the Japanese treasury market, which undermines its attractiveness as a haven for savings. As for the Indian Rupee, it's not widely considered a potential reserve currency due to several reasons:   <ol> <li>While a large and growing economy, it still needs the scale and global financial integration comparable to economies like the US or the Eurozone. The depth and liquidity of India's financial markets are also relatively limited compared to these economies.</li> <li>The Indian Rupee is not a fully convertible currency, which is a fundamental requirement for a reserve currency. India also faces fiscal deficits, inflation, and regulatory uncertainties that could deter international investors.</li> <li>The Indian economy is still developing, with significant parts relying on informal sectors, which adds to the unpredictability and risk factors associated with the Rupee.</li> </ol>   For a currency to be a reserve currency, there needs to be immense trust and stability associated with it, which currently, the Indian Rupee does not universally command. The Euro has also been touted as a possible reserve currency. Yet, just a few years ago, there were talks of Greece leaving the Euro, and with more anti-EU parties gaining prominance in Europe, investors are unlikely to want to hold a currency that could potentially disintegrate. With the EU economic area also slowing down and an ageing population, it doesn’t look like a viable reserve currency. Looking towards the future, it is natural to assume that China will become the next leader, given its size. According to the World Population Prospects 2022, published by the United Nations Population Division, China is projected to have a population of 771.3 million by 2100, while the United States is projected to have a population of 393.9 million by 2100. If the average Chinese resident earned the same as the average US resident, the Chinese economy would be 1.95 times bigger than the US economy – making China an obvious reserve currency candidate. Yet, as mentioned above, many changes are required before that can happen. And maybe the most significant change required is for them to turn into a democracy, something that is not likely any time soon.   <h2>Effects of de-dollarisation in the global markets</h2>   With the dollar being so widely interlinked with the global markets, the continuation of the de-dollarisation movement and any moves within it could increase market volatility on a global scale. Here are some of the potential effects of de-dollarisation on the global markets:   <h3>Forex</h3> The biggest risk of de-dollarisation is that the value of the USD drops in value as people sell the USD and move into other currencies. A lower-valued USD would also increase inflation in the USA and, in the worst case, create a catastrophic situation if confidence is lost, as the US would be spending more than it earns. Borrowing as a percentage of GDP is 103.4%. <img alt="" src="/getmedia/93b74b1a-d874-49fd-9c58-a9bd68cdf600/Market-Events_De-Dollarization_forex.webp" /> In 2022, the Euro was the second biggest currency reserve held at roughly 20.5% and likely the short-term winner. In the long run, and following changes to their capital control and economy, the Chinese yuan is a likely winner. <h3>Cryptocurrencies</h3> <img alt="" src="/getmedia/f90f6298-340a-4f51-89f9-7a68097b24bd/Market-Events_De-Dollarization_cryptocurrencies.webp" /> Cryptocurrencies emerge from the belief that traditional fiat currencies are flawed and that governments often exert excessive control over individual finances. This viewpoint gains momentum in scenarios where high inflation occurs or government actions restrict financial freedom, such as imposing a €10,000 limit on cash transactions in the EU or the financial controls seen in Cyprus. Cryptocurrencies are often touted as a solution in these contexts, offering an alternative to government-regulated monetary systems. Amidst these developments, the cryptocurrency market is regaining attention as a viable investment option. Major cryptocurrencies like Bitcoin and Ethereum have shown resilience and growth as they gain acceptance among more institutions as possible alternatives to fiat currencies. <h3>Stocks</h3> <img alt="" src="/getmedia/5dea3aff-0ac3-4fda-88f5-763eff5430ad/Market-Events_De-Dollarization_stocks.webp" /> The US stock market has strong relations to the dollar but it’s not as straightforward as you might think. Some companies would rather have the dollar depreciate than appreciate. Let’s look at the two scenarios. When the dollar appreciates, US companies that import raw materials, energy or commodities to manufacture goods and services will feel the blow on their balance sheets. If de-dollarisation continues, the purchasing power of the dollar decreases. This means manufacturers will have to spend more to buy the same amount of materials, putting significant pressure on profit margins. Stocks and indices tracking companies that publish worse-than-expected earnings reports often find themselves in a downward trend. On the other hand, if the dollar depreciates, US companies that export goods and services will fare better. The inflow of foreign currencies traded against a weaker dollar will mean companies have higher profit margins. At the same time, American goods and services will become more affordable in the global market, creating massive appeal for US products. Check out how to trade stocks with CFDs <a href="/uk/trading-academy/cfds/how-does-cfd-trading-work/">here</a>. <h3>Gold</h3> <img alt="" src="/getmedia/d0d287eb-90b1-4fd9-a24f-a301e9db3711/Market-Events_De-Dollarization_Gold.webp" /> The potential political and economic fallout from de-dollarisation will likely push anxious investors to turn to gold for protection. Gold bugs have for years been using the high US spending and inflation as a reason to get more people to buy gold. Also, seen as a safe-haven asset, gold shines the most during a crisis. Should nations completely abandon the greenback, it’s safe to say that there will be a window where gold rises in value before investors embrace the USD’s replacement. The decreased dependence on the US dollar will significantly impact the financial markets, presenting CFD traders with various opportunities to go long or short on various instruments.

6 min readBeginners

Indices

What Is the DAX 40 and How to Trade It?

The DAX 40, also known as the DAX Index, is a blue-chip stock index following the largest German companies listed on the Frankfurt Stock Exchange. It’s also a reliable indicator of the country’s economic strength. It’s considered to be the benchmark stock market index for the German economy. <h2>What Is the DAX 40?</h2> The index tracks the 40 largest German companies in terms of market cap and liquidity. DAX is short for Deutscher Aktien Index 40 and it was established with a base value of 1,000 in 1988. Since 2006, the Xetra trading venue has been computing the index’s price every second.   When the DAX 30 became the DAX 40 on September 20 2021, the Deutsch Boerse admitted ten more companies to the index, meaning a slightly broader range of sectors covered, as well as other regulatory provisions. The DAX 30 became the DAX 40 on September 20 2021.   Additions to the index were Airbus, Zalando, Siemens Healthineers, HelloFresh, Symrise, Sartorius, Porsche Automobile Holding, Brenntag, Puma and Qiagen.   The DAX is a performance-based index as it incorporates data on company dividends, capital income and cash outflow, which are included in the net stock price, while a pure price index would overlook corporate distributions.   Similar to DAX, other blue-chip stock indexes are the CAC 40 in France, the FTSE 100 in the United Kingdom, and the S&P 500 index in the United States.   Since its inception at the end of 1987, the DAX has mirrored other indices during major economic events throughout history, including the tech bubble in 2000, significant lows in 2003, as well as other fluctuations over in subsequent years. The index plunged in 2008 amid the global financial crisis and did again during the global Covid-19 outbreak. <h2>How Is the Index Calculated?</h2> The DAX 40 is computed through the free-float methodology, which means that it takes into consideration only the readily available shares and it doesn’t take into account shares that are untradable, like those owned by governments.   Like other blue-chip indices, the DAX Index is also weighted by market cap, so companies with higher market caps have more influence on its value. Companies included in the DAX can have a maximum weight of 10%.   The prices used to compute the index come from Xetra, an electronic trading system. The index tracks the performance of Germany's 40 biggest companies by order book volume and market capitalisation. <h2>DAX Components</h2> Here are some of the most popular components of the DAX 40:   <ul> <li>Adidas AG (ETR: ADS) - a popular design and clothing company headquartered in Herzogenaurach, Germany.</li> <li>Airbus SE (EPA: AIR) - an international pioneer in the aerospace sector designing manufacture and deliver industry-leading commercial aircraft.</li> <li>BASF SE (ETR: BAS) - one of the largest chemical producers in the world, with 390 production plants around the world.</li> <li>Bayer AG (ETR: BAYN) - a pharmaceutical company that produces some of the most popular pain relief drugs.  </li> <li>BMW AG (ETR: BMW) - a well-known automaker that has manufactured various award-winning models.</li> <li>Deutsche Bank AG (ETR: DBK) (NYSE: DB) - one of the largest banks in the world, operating in 58 countries in Europe, Asia and the Americas.</li> <li>Siemens AG (ETR: SIE) (NYSE: SI) - an electronics manufacturer and electrical engineering services provider operating in a wide array of market industries. </li> <li>Volkswagen AG (ETR: VOW) -  the largest automobile manufacturer by worldwide sales in 2016 and 2017.</li> </ul> To be included in the DAX 40, a company must first be listed in the Prime Standard segment on the Frankfurt Stock Exchange. Companies that belong to this segment have to meet higher standards of transparency than companies listed on the General Standard segment.   Additionally, the company should be continuously traded in Xetra with a public float of at least 10%. Another requirement is to have an office registered in Germany with most of its volume of shares traded in Frankfurt, and be headquartered in one of the EU countries. <h2>Correlations</h2> According to Blackwell Global, the DAX 40 has a more than 90% correlation with major US stock indices and a 70% inverse correlation to the Euro. The correlation between the DAX and its US counterparts has deviated at certain periods, for example when the 50-day correlation between the two went negative in 2018, indicating that underlying trends affecting worldwide assets temporarily changed.   For instance, if the EUR/USD currency pair advances, the DAX index usually depreciates, and on the other hand, when the Euro depreciates against USD, the DAX moves up. This phenomenon  is used by traders to develop a successful trading strategy.   Another interesting fact is that the DAX is quite responsive to the European Central Bank or ECB policies. Major news releases in the Eurozone are likely to affect the index. This is because the correlation strategy helps mitigate risk since you’re making decisions based on proper information.   The correlation between different currency pairs and indexes can range between -1 to +1, and if the two instruments advance in the same direction, that’s an indicator of an ideal positive correlation. On the other hand, an ideal negative correlation would mean that the pairs or indexes will always advance in the opposite direction.   Finally, if the correlation coefficient is 0, the directions of two currency pairs or indexes are completely independent. While understanding the DAX, correlation strategy can be of great help for risk management, traders and analysts should know that correlation only matters when it comes to the directional relationship and not the scale of the movement.   For example, if the Euro is falling sharply, the DAX will likely rise, but not as sharply. Also, when developing your correlation strategy, keep in mind that correlations sometimes can fade unexpectedly. <h2>Historical Performance</h2> As a leading German index and home to major German stocks, including BMW, Deutsche Bank, VW and Siemens, the DAX 40 has always been closely followed by investors.   The DAX 40 posted large gains, tracking other global indices during the 1995 dotcom bubble when stocks were led higher by U.S. technology stock valuations.   In the five years between 1995 and 2000, the DAX Index gained 300%, rising to a record high of 8,000 from about 2,000. In the next seven years, the price action traded in a V-shaped fashion, plunging to 2,220 in 2003, before rising again to match the 2000 high in 2007. <img alt="" src="/getmedia/e1b95476-2617-4006-9e9e-bef1975fe76e/Dax-30-image-1.jpg" />   The 2008 global financial crisis facilitated another pullback before DAX 40 started to ascend again. This led to a continuous uptrend with three cyclical corrections in 2011, 2015, and 2018.   In 2020, the DAX Index was trading at record highs before the Covid-19 pandemic triggered the fastest stock market selloff in history. The DAX 40 went from trading at 13,800 to 8,250, dropping 40% in just four weeks’ time. <img alt="" src="/getmedia/2ca87af0-98fd-4c6e-aa81-5157051539f5/Dax-30-image-2.jpg" />   What might happen from here is that the buyers will look to take out the February all-time high and eventually push the price above 14,000. In this regard, the bulls may look for a move to 14,500, where the 127.2% Fibonacci extension of the 2018 retracement is located.   Alternatively, a more positive global risk sentiment may yield a trading environment that is bullish for European indices. In this case, the bulls would look to push the DAX 30 towards 15,300 where the 127.2% Fibonacci extension resistance of the coronavirus-fueled market retracement sits. <h2>Spread and Leverage</h2> While it carries significant risk, Institutional and retail investors also tend to spread-bet on the DAX. As a derivative product, spread betting doesn’t let you take ownership of the underlying asset. Instead, traders speculate on whichever direction the price will move in the future.   Leverage is a key element of spread betting, as it allows traders to increase market exposure. Hence, investors tend to leverage DAX to potentially magnify profits, but also losses. For this reason, it is important to create a sustainable risk management strategy, bearing in mind the amount of capital that you are putting at risk. <h2>Summary</h2> <ul> <li role="presentation">The DAX 40, also known as the DAX Index, is a benchmark German stock market index following the 40 largest German companies.</li> <li role="presentation">The DAX index is home to major German stocks, including BMW, Deutsche Bank, VW and Siemens.</li> <li role="presentation">DAX is the German counterpart of the French CAC 40 index, the British FTSE 100, and the U.S. S&P 500 index.</li> <li role="presentation">Understanding the correlation between the DAX and other indices in some detail can be of great help when working on a trading strategy.</li> </ul>

5 min readAll

Indices

How to Use the Forex Index Strategy in Trading

The force index indicator is a technical tool used by traders to measure the power behind movements in the price action. It belongs to the family of oscillators. This strategy was first documented by Alexander Elder, a trader and psychologist, in his 1993 book titled Trading for a living.   In this blog post, we look at the basics of the force index indicator, how it is calculated, how to interpret its readings, and we share with you a simple trading strategy. <h2>How is it calculated?</h2> The force index indicator is based on price action and volume. In essence, the indicator compares the current market price with a prior market price, and multiples it with a volume over the same period.   Based on a formula shared below, the indicator measures the strength of price movements and generates signals of potential changes in the price direction.   The formula for calculating the force index is as follows:   FI(1)=(CCP − PCP)&lowast;VFI(13)=13-Period EMA of FI(1) The elements of this formula are: FI = Force index CCP = Current close price PCP = Prior close price VFI = Volume force index EMA = Exponential moving average      Almost all <a data-di-id="di-id-50880195-24d8837" href="https://www.thinkmarkets.com/en/trading-platforms/">trading platforms</a> nowadays have a built-in force index indicator, hence, you are not required to manually calculate the values. In <a data-di-id="di-id-6e0d35b7-1d3b3793" href="https://www.thinkmarkets.com/en/trading-platforms/mt5/">MetaTrader5</a>, you simply select the indicator from a drop-down menu of listed indicators, as shown in the picture below. The standard average, on which the force indicator is calculated, is 13 periods. <img alt="" src="/TMXWebsite/media/TMXWebsite/Force-Index-pic-1.jpg" />   Arguably the most important use of the force index indicator is to confirm breakouts and potential trend changes. It generates readings that inform the trader about the strength of a current move as values travel from a positive to a negative territory, and vice versa.   An interesting characteristic of this indicator is that it has no bounds i.e. its values can travel up or down indefinitely. If the index goes above zero - a rising force index - it is confirming the rise in the price action. On the other hand, a falling force index generates values below zero and helps confirm a price action that is moving lower.   In a picture below, you can see the applied indicator on a NZD/USD daily chart. The values travel from positive to negative territory as the index calculates the amount of power used to move the price action around. <img alt="" src="/TMXWebsite/media/TMXWebsite/Force-Index-pic-2.jpg" /> <h2>Strengths and weaknesses</h2> As said earlier, the force index measures the power deployed by sellers or buyers behind market movements. As such, the indicator is very effective as it practically verifies the legitimacy of a movement i.e. if the breakout is followed by a spike in the direction of a breakout it helps confirm the breakout. On the other hand, breakouts without high readings (lower volume) have a higher chance of ending up as false breakouts.   The lower force index values are usually associated with the sideways price action, as volume is lower and price movements are not as sharp as during the breakouts. Thus, the force index readings spike in value during an uptrend and fall during downtrends.   When it comes to the negative aspects of the force indicator, it shares the key weakness of all lagging indicators. Due to their inherent design, lagging indicators use prior price and volume data to calculate the readings. As such, they may be slow in generating signals.   For instance, the force index indicator may confirm the breakout a few sessions after the price had broken out initially. Hence, you may be stuck waiting for confirmation while the price action has already travelled significantly in a certain direction.   Trading the Force Index Indicator The role of the force index indicator in the trading process is very similar to <a data-di-id="di-id-6e6e2526-2f44eb08" href="https://www.thinkmarkets.com/en/trading-academy/indicators-and-patterns/stochastic-oscillator/">other oscillators</a> and lagging indicators. Given its design, the best way to use this technical tool is to see it as a tool for confirmation of the breakouts.   The first step would be to perform a basic technical analysis and identify important price points from the perspective of supply and demand i.e. support and resistance. Once we have marked these levels on a chart, the base is set to monitor the price action closely, and wait for a potential breakout to the upside or downside to occur.   Let’s see an example of how to use the force index to confirm sharp movements in the price direction. We have a AUD/USD daily chart below, whose price action we can divide into two parts. The left part of the chart is characterised by the sideways price movement, which generates values around zero.   On the other hand, the right part of the chart is when the pair is moving sharply in both directions. As a result, the force index indicator is following the price movements up and down as well. <img alt="" src="/TMXWebsite/media/TMXWebsite/Force-Index-pic-3_1.jpg" />   The bulls fail in an attempt to push the price action higher above the horizontal resistance, which opens up the space for the sellers to secure a bigger move lower. This time, the second attempt from the sellers to push the price action to the downside is followed by a sharp decline in values of the force index indicator - falling force index - signalling that this time there is a significant force behind this move.   Ultimately, the sellers get a move of around 1,000 pips lower. At the point where the second move lower was initiated, the force index reading was at minus-85.   Entry (the blue line) should be placed at the point where it is obvious that the buyers failed to push above the horizontal resistance i.e. a change in the price direction is imminent. The stop loss is above the horizontal resistance, meanwhile we placed the take profit order where the first move lower was capped (the green line), as we have clear evidence that this level is a support now.   Ultimately, we risked 105 pips to earn 155 pips, putting the risk-reward ratio at around 1:1.5, which is acceptable. <h2>Summary</h2> The force index is a technical indicator which is used to calculate the power behind movements in the price action. As such, the indicator is mainly used to confirm the breakouts and identify potential changes in the trend direction. It is based on the formula that compares the current market price with a prior market price, and multiples it with a volume over the same period.   The force index indicator belongs to the family oscillators and generates values that can travel up or down indefinitely.

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