What are Indices?

An index is usually defined as a portfolio of stocks; it is the statistical measurement of the value of a part of the stock market. Most economies and developing economies have a minimum of one financial index. For example, worldwide the Dow Jones Industrial Average (DJIA) is one of the most readily used indices. The DJIA is consists of stocks from the 30 largest companies in the America,  thereby representing approximately 25% of the American market. Similarly, the S&P 500 index includes 500 of the most widely traded businesses in the US. The S&P 500 represents around 70% of the total value of the US financial stock markets. Since the S&P 500 is larger and more diverse than the DJIA, it gives a wider representation of the entire status of US stock market.

An index is usually represented in terms of points. Each specific index is calculated in a particular manner.  Its current worth is often represented by a weighted average of the values of its stocks. Therefore, an index’s value fluctuates on a daily basis based on the fluctuating values of its individual stocks. Accordingly, an index can be an accurate, up-to-date representation of a country’s economy or a particular industry.

In order to trade indices, traders can hold out on a specific index if they believe that stocks have a potential to increase in the future or let go of an index if they believe that the index will likely drop in value soon.

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Comprehending an Index’s Stocks

Most Popular Financial Indices
The most efficient way of analysing an index is by understanding the stocks that make up an index. Different indices have different focuses on depending on certain types market sectors or stocks. For instance, the NASDAQ index mostly includes technology stocks and therefore generally measures the performance of the technology industry. But keep in mind that the NASDAQ also lists various stocks from other industries like the finance, insurance and transportation industries).

By monitoring indexes and observing their movements over time, traders can have the upper hand and know what will be investors’ actions towards a range of companies and market sectors.

The most widely traded indices are:  

  • The S&P 500 and Dow Jones (New York City)
  • The Hang Seng (Hong Kong)
  • The Nikkei 225 (Tokyo)
  • The FTSE100 (London)
  • The DAX30 (Frankfurt)
  • The Shanghai Composite

 

CROSS-LISTING

Cross listing refers to when many multinational corporations list their stocks on one or more foreign stock exchanges, as well as on their own domestic exchange.

Thus, when a company’s local index is closed, its assets may be still tradable on another open, international index. Cross-listing can help increase the liquidity of a company’s stocks, because it allows traders to choose from a range of markets from which to trade a particular share.

 

ROLLING DAILY AND FUTURES

Financial indices can be traded on two formats either in rolling daily format or in the futures format.

Rolling daily trading is when trades are “rolled over” from one day to the next, these deals will stay open until the trader decides to close their position, or when their stop-limit order or stop-loss order is reached. It is important for new traders to note that rolling daily contracts apply charges to a trade for each night the trade is held open.

Trading in futures is when traders are given or can choose a fixed expiration date and time. When this occurs, their standing on a trade will automatically close. In contrast to rolling daily contracts, futures trading does not accumulate overnight fees.

How to Trade Indices

Indices: The Trading Process

By trading indices, traders can predict whether an index will rise or fall, without actually buying shares in the underlying assets. In this respect, trading an index is similar to trading a stock, currency or commodity.

To make a profit, a trader can choose to either sell an index at a higher price than its initial cost(buy); on the contrary,  a trader can buy an index at a lower price than they originally sold it for.

An index’s overall value is calculate by the entirety of tits shares, therefore, rising or falling value of the index depends on the performance of its collective stocks. To clarify, if and index is up, and more investors are buying than selling, then share prices will increase. However, if more shares are being sold than bought, the index will instead decline.

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Trading on Indices vs. Trading on Equities

A stock’s value can provide you with insights into the financial state of a particular company, while indices are portrayals of markets and market sectors. It is important for traders to review events that may affect the value of an index, such as monthly employment reports, geopolitical news, and economic reports.

On the other hand, when trading individual equities, traders would be wise to track more specified company-related news about defects and recalls, new product leaks.  Additionally, for those trading equities keep an eye out for future potential mergers, acquisitions, and company’s earnings release announcements.

These essential elements have the potential to dramatically and rapidly move an individual company’s stock prices. By contrast, trading an index exposes a trader to such risks, but at a much lower level.

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The Volatility of Indices

Indices are usually  made up of a set of stocks, but the constant, acute movements of share prices can  indices relatively volatile. Don’t fear, it is highly uncommon for all the stocks listed on an index to  simultaneously encounter major movements. Not that it is quite rare for indices to move by more than two points a day.

Nonetheless, there have been extreme cases where this has occurred. For example, any stock market crashes. The most famous amongst these are the US Market Crash of 1929 and Black Monday, the US stock market crash of 1987 – in which by the end of one day, Black Monday, the Dow Jones fell by 22.6% in value.