Trading the FTSE

Trading the FTSE
Written by Andy

The ‘Footsie’ or FTSE 100 index started in 1984, and was based on the hundred largest companies listed on the London Stock Exchange (LSE). The initials FTSE come from the Financial Times and the London Stock Exchange, the London part being dropped as unpronounceable. Often the FTSE is seen as an indicator of the strength of the British economy, and is arguably the most important index in Europe. The FTSE 100 companies represent about 80 % of the UK share market.

But with that as general background, how should you approach trading the FTSE? Things are not really what they seem once you start delving. Even since 1984, the majority of the companies that formed the index have dropped out. The index is reshuffled every quarter, with the aim that the hundred companies are fairly representative of the greatest market capitalization. They don’t immediately move the company out if it falls to 101, but if it fell to, say, 111 then it’s likely it would go.

As for it representing the British economy, research in 2006 found that 60% of the revenues of the FTSE 100 companies came from outside the UK. This perhaps isn’t so surprising, when you realize that the largest of the large caps are represented in the index, and large companies usually have a lot of international trade. In fact, most of the top 10 companies in the index don’t even report their profits in sterling, but in US dollars. So it’s not surprising to see that the FTSE 100 is highly susceptible to the world economy, rather than just that of Great Britain.

At best, the FTSE 100 is a global index with a British weighting, and therefore you have to expect it to react to world events in an appropriate manner. As an example, changes in commodity prices affect the FTSE 100 much more than any other general financial index in the world. Because of the way it is made up, the FTSE 100 has a heavy bias towards oil and mining stocks. Between them, they constitute about 30% of the index, purely because these are the gargantuan companies.

In all, there are five oil companies in the FTSE 100, and their share prices, and consequently the FTSE 100, are much more affected by happenings in the Middle East than in Britain. Surprisingly, 11 of the 100 companies in the index are concerned with mining, and with little mining now happening in the UK, their prices are affected more by the events in China. To be successful trading the FTSE you need to be aware of the constituent companies and their international involvements. They are by no means a cross-section of industry, but merely the result of taking the largest capitalized firms to make up the index.

If you have a blue chips shares investment portfolio you might also consider using the FTSE 100 as a hedge in turbulent times. For instance, if the FTSE is trading at 6,700, a short CFD position might profit the trader £1 per one point move in the index (in this scenario one FTSE CFD = £6,700 worth of exposure). An investor who holds a number of FTSE 100 equities with an aggregate valuation of £13,400 would require two CFD shorts for a full hedge. Of course, this assumes that the investor’s portfolio mirrors the FTSE 100 index which is rare. If you try to hedge a portfolio that is quite different from the index, this might leave you with losses on both your shares portfolio AND your index hedge; case in point being if the index rises while your shares decline in value.

The FTSE 100 can be successfully traded, but you have to do your homework and look up the factors that will have a significant impact on it. Don’t assume that they are what you thought they were.

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