How To Trade The FTSE 100

Ok, so we’ve all heard of the FTSE 100 (^FTSE), the main stock market index in the UK. We observe it by osmosis every evening on the news. Unfortunately this doesn’t make us experts and I’m sure that there is plenty of relevant information that you didn’t know about this quirky index. For starters, did you know that you can’t really trade the FTSE 100 Cash index that we hear about all the time? Would it surprise you to hear that there are 11 mining stocks in the index, by far the most represented industry? Read on and we’ll find out how to trade this index more profitably.

What Is The FTSE 100?

Starting with the basics, the FTSE 100 is an index of 100 of the largest companies traded on the London Stock Exchange. Its 100 companies represent about 81% of the market capitalisation of the whole London Stock Exchange (LSE). It gets its name from the FTSE Group, which is 50/50 owned by the Financial Times and the London Stock Exchange, hence FTSE - FT and SE.

The FTSE 100 was launched on the 3rd January 1984 and had a start value of 1,000. Since then the make-up of the index has changed almost beyond recognition - mergers, takeovers and bankruptcies have all meant the index only has 21 of the original constituents are left in it. BP (BP.L) is one such survivor. Its market cap of £7.4bn in 1984 was good enough for the largest weighting in the index, but its £99bn value now is only good enough for third billing behind HSBC and Royal Dutch Shell. A fair number of constituents have changed their names too. Do you remember Commercial Union Assurance (now Aviva) or British Gas (now BG Group and Centrica)?

Changes In The Constituents
The process for reviewing the constituents in the index is straightforward. All companies listed on the LSE are ranked in order of their market capitalisation. A committee made up of independent market experts meets in March, June, September and December and considers which companies should be allowed into the FTSE 100. If a company is in the FTSE 250 (top 250 companies not currently in the FTSE 100) but is ranked in the top 90 LSE companies by market capitalisation, it can enter the FTSE 100. On the other side, if a FTSE 100 company falls to 111th position or below, there’s a good chance that it will get kicked out. In the latest set of changes in June 2009, 3I Group, London Stock Exchange Group and Wolseley entered the index, replacing Amlin, Drax Group and Whitbread. The next quarterly reshuffle takes place on the 9th of September with Segro, Rentokil Initial and Tate & Lyle the favourites for promotion. To keep yourself up to date, here’s a continually updated list of constituent changes.

The FTSE 100 Isn’t Purely A UK Index

Despite the common misnomer that the FTSE 100 is a pure representative of the UK economy, it simply isn’t due to the numerous international stocks in the index. In 2006 research showed that roughly 60% of the revenues of FTSE 100 companies came from outside the UK. Even more surprisingly, most of the top 10 FTSE 100 companies don’t even report their results in Sterling, but use US Dollars instead. Trading the FTSE 100 exposes you to a lot more than simply the ups and downs of the UK economy. The largest company in the FTSE 100 that could properly be described as a British, rather than a global company, is Tesco at 12th and even the supermarket behemoth is increasingly exposed to international markets.

If the FTSE 100 isn’t UK Plc, then what does it represent? In my opinion, the FTSE 100 is a globalisation index that is strongly weighted with UK companies. For example, despite the demise of mining in the UK, the FTSE 100 still manages to have 11 gigantic miners in it, all of whose share price are hugely affected by what goes on in China. Also five gargantuan oil companies call the FTSE 100 their home despite their share prices being little affected by what goes on in the UK. The Middle East is a better place to try find out what’s driving their share prices. Those two industries alone make up about 31% of the index. In general, commodity price changes have a much larger effect on the FTSE 100 than any other major world index. My point here is that when you’re trading the FTSE 100, keep an eye on what is driving the larger underlying components. It’s completely possible that if you get an unexpected rise in UK Retail Sales and a simultaneous fall in Brent Crude Oil that the FTSE 100 may actually fall. I’ve done up a list of the 100 companies currently in the FTSE 100 with their weightings and the industry they’re in.

Trading The FTSE 100

As I alluded to earlier, you don’t really trade the FTSE 100 figure that you see on the evening news. That figure is the FTSE 100 Cash price that is calculated every 15 seconds on every week day (excluding UK public holidays), from 08:00 when the market opens until 16:30 in the afternoon when it closes. The Cash price is only calculated when the underlying constituent companies are open for trading.

However a calculation every 15 seconds is too long of a gap and a trading session that lasts only 8½ hours is simply too short for the fast moving financial world that we live in. Enter the FTSE 100 Future. With paddypowertrader, this opens for trading at 07:00, runs until 21:00 and is calculated every second. For all intents and purposes, the FTSE 100 Cash and FTSE 100 Future are identical as they are both based off the underlying 100 companies share prices. When the FTSE 100 Cash is open for trading, the Future reflects the movement of it. When the Cash and constituent companies are closed, the Future reflects what is happening in the overall market. As the Future is open for longer, there is a lower chance of it gapping in price, which is always good for us traders.

There are also quarterly FTSE 100 contracts that are designed to allow traders run a position in a share for several weeks or months. The quarterly contracts are FTSE March, FTSE June, FTSE September and FTSE December. They typically trade at a slightly different price to what the FTSE 100 Future is trading at. However it is important to note that a premium or discount in price is mechanical and does not reflect a bullish or bearish view on the part of the market. The Future price is adjusted upwards for interest rates and downwards for dividend yields to get to the FTSE 100 Quarterly price. Usually the Quarterly price is higher than the Future price as interest rates dominate. But currently, with interest rates so low, the FTSE 100 December price is lower than the FTSE 100 September price which is slightly lower than the FTSE Future price.

Where Next For The FTSE 100?

As I write, the FTSE 100 is hovering around the 4,900 level, a landmark not seen since early October last year. Considering the tremendous amount of short-term upside momentum, a break of 5,000 shortly looks inevitable. For a sustained break through that psychological level, what will be important will be (1) a continued rise in commodity prices, (2) further improvement in economic data and (3) bullish statements from Central Bankers. A slip in any of the three could see the FTSE 100 slide back to 4,500 so keep your eyes and ears sharp to any negative changes. After such a strong rally, it’s arguably easier for the FTSE to fall back 500 points than for it to rise another 500.

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