Synthetic indices have grown in popularity since their launch back in the early 2000s. Many traders seeking opportunities outside the traditional trading instruments have always turned to trading synthetic indices.
Although synthetic indices are often discussed alongside forex trading, they differ significantly in how prices are generated and what drives market movements. In this guide, we will discuss the differences between the two to help you make more informed decisions when diversifying your portfolio.
What Are Synthetic Indices?
As the name suggests, synthetic indices are designed to simulate real market conditions. Behind the scenes are an algorithmic model and random number generators that simulate price movements and replicate different levels of market volatility.
Since they are not tied to the operating hours of global financial exchanges, synthetic indices are available for trading around the clock, including on weekends and public holidays. This continuous availability is what makes them attractive to traders.
Something else worth pointing out is that synthetic indices are categorized according to the type of market behavior they simulate. For instance, crash and boom indices mimic sudden price spikes and crashes.
Synthetic Indices vs Traditional Forex Trading
What are synthetic indices in forex? Although forex trading and synthetic indices share many similarities, they operate in fundamentally different ways. Understanding these differences is essential if you are looking for an instrument that best aligns with your trading style and investment goals.
- Market Drivers
The biggest difference between synthetic indices discussed on Syntxwiki and forex lies in what drives price and volatility. In traditional forex markets, these two are driven by real-world events. Geopolitics, central bank policies, supply and demand, inflation reports, and other factors all influence currency prices.
Synthetic indices, on the other hand, are immune to economic and geopolitical events happening across the globe. Instead, their prices are generated with sophisticated algorithms designed to simulate realistic market behavior and varying levels of volatility.
- Trading Hours
The forex market operates 24 hours for 5 days a week, closing on weekends and international public holidays.
Synthetic indices are available for trading 24 hours a day all year round. This feature has played a role in making synthetic indices popular among traders seeking to diversify their portfolios. Moreover, with synthetic indices, you don’t have to worry about time zones, which is an issue in forex trading.
- Volatility Characteristics
Volatility is an interesting feature in trading. Forex volatility varies depending on market sessions, economic announcements, and geopolitical developments. Periods of high volatility in forex often lead to immense, rapid price fluctuations.
Synthetic indices’ volatility varies depending on the index. Some indices simulate steady price action, while others replicate highly volatile market conditions with frequent, massive price swings.
Because the volatility in synthetic indices is built into the algorithm, you can select indices that match your preferred level of market movement.
- Liquidity and Market Participation
The forex market is massive, transacting billions of dollars daily in trading volume. Its liquidity pool includes various stakeholders, from retail traders to large corporations and banks.
What are synthetic indices in regard to liquidity? Synthetic indices do not have traditional market participants. Since their prices are generated using proprietary algorithms rather than determined by buyer and seller activity, liquidity is not dependent on market demand or institutional participation.
As a result, when trading synthetic indices, you will experience steady pricing without the liquidity shortages that often affect certain forex pairs during off-peak trading sessions.
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