The synthetic index market is getting more traction every day. Traders are migrating to it because of its unique features. If you have just heard about synthetic indices and you want to begin trading them, it is nice that you first understand the type of synthetic indices available and how they are simulated.
The synthetic index market is categorized based on the fundamental asset from which it is simulated. We have many different types of synthetic indices, but here we will cover only five, which are the ones available on most brokerage platforms.
So, let’s get started.
5 Types of Synthetic indices.
The major types of Synthetic indices are Volatility indices, boom and crash indices, Daily reset indices, range break indices and jump indices.
Each of this Synthetic indices has a different real world assets of which it is simulated from. Let’s go through them one-by-one.
#1 – Volatility indices
Volatility indices are index gotten by simulating the volatility of S&P 500 stock.
Volatility, as we know, refers to the rate of price fluctuations of a particular asset. In this case, volatility indices are created by observing and converting the rate of fluctuation of the S&P 500 price into a tradable asset.
The term “volatility index” is shortened to VIX. This asset is tradable in the form of the VIX 10, VIX 25, VIX 50, VIX 75, and VIX100 indexes. The number appended to each of these “VIX” is a measure of the level of volatility of the S&P 500 stock. At volatility above 30%, the market is said to be in fear mode. Hence the VIX 50, VIX 75, and VIX100 indexes are available as high-risk tradeable products.
The units of movement of this assets (Volatility indices) is measured in tick. A tick is the smallest price movement obtainable in this financial market. Still confused about what tick is ? If you grounded on forex trading, you can relate tick in volatility indices as pip in forex trading.
Basically, we have two form of VIX market based on the time it takes for a tick to form. We have one-second and the two-second VIX.
A tick is generated every second in the one-second VIXs, so we have a VIX 10 (1 s) index, VIX 25 (1 s) index, VIX 50 (1 s) index, VIX 75 (1 s) index, and VIX 100 (1 s) index.
On the other hand, a tick is generated every two seconds for the two-second VIXs, hence we have the VIX 10 (2 s) index, VIX 25 (2 s) index, VIX 50 (2 s) index, VIX 75 (2) index, and VIX 100 (2)
#2 – Boom and crash indices.
The Boom and Crash indices are another synthetic index market known for sudden spikes or breakdown in price movement, which can cover up to 50 pips within a minute.
These assets are not pegged to the USD or any other traditional currency, so they are unaffected by fundamental factors.
The boom and crash market is of four forms: the boom 1000 index, the boom 500 index, the crash 1000 index, and the crash 500 index. The numbers appended to each of these indexes are a measure of the relative volatility of the asset. Hence, a boom of 1000 is more volatile than a boom of 500. However, the reverse is the case for crash indices. Crash 500 is more volatile than Crash 1000.
The boom indices are identified by sudden large spikes that can cover up to 70 pip price increments in a minute, whereas the crash indices are identified by a sudden breakdown in price that can cause up to a 70 pip loss in asset value within a minute.
So traders mainly trade the Boom and crash by going long when they spot a potential price spike or going short when they spot potential price breakdown.
Recommended: Best time to trade Boom and Crash.
#3 – Range Break Indices.
A range-break index is a synthetic index that fluctuates between two price points known as borders. The upper price point of this border is the resistance level, while the lower price point of this border is the support level. After the prices fluctuate within a range for some time, they occasionally break above or below the border to form another border.
We have Range Break 100 and Range Break 200, with the numbers coming after “Range Break” denoting the average number of times that price hit the border before it broke above or below to form another border.
There are many brokers that offer this asset. The most popular and trusted of them is Deriv.com. I have had a better experience using them in my trading career.
4 – Jump Indices.
Jump indices are synthetic indices characterized by sudden price movement, just like the boom and crash markets.
This sudden price movement is due to the timed buying and selling implemented by the high-frequency traders.
Before you can understand how jump indices are simulated, you need to understand the concept of jump trading.
Jump trading is a trading strategy implemented by high-frequency traders over an asset.
Still confused about what jump trading means? Let’s demonstrate with an example.
Let’s say a retail investor(high frequency traders) holds 100 shares of a particular stock when the market is neutral (i.e., the price is relatively stable) at a price of $80 per share. If, as time goes on, institutional investors decide to get some shares of the stock with the faith that it will appreciate with time, this demand will cause the price of the stock to rise to something like $90 per share, considering that institutional investors usually put millions of dollars into stock.
At this point, the first investors(high frequency traders) have made 10 dollars per share, so they can jump in and sell their shares and then start waiting for when the institutional investors will sell off so that they can jump in again and acquire some assets. This form of trading adopted by retail investors(high frequency traders) is what is known as “jump trading.”
Having explained this, I hope you are better set to understand what jump indices are.
Jump indices are virtual products designed by observing and simulating the trading strategies of high-frequency traders( jump traders). We have the Jump 10 index, Jump 25 index, Jump 50 index, Jump 75 index, and Jump 100 index, with the appended numbers representing the level of volatility of the particular index, just like in volatility indices.
#5 – Daily Reset Indices.
Daily reset indices are programmed assets that reset their bullish or bearish trend daily. The resetting usually occurs at 12 midnight GMT daily. Just like other synthetic indices, daily reset indices have a constant volatility, hence enabling traders to develop trading strategies and trade them successfully.
Recommended: Top 6 Best Synthetic Indices to Trade in 2022
The five major types of synthetic indices are volatility indices, boom and crash indices, step indices, range break indices, and jump indices.
One thing to keep in mind is that none of these indices represent a real market asset. They are rather like written programs that simulate other real-world markets. So you can easily trade them without the influence of fundamental factors like news, etc.
If you have any questions regarding this asset, you can leave them in the comment section below. I will do my best to answer them.