In its most regularly traded format, an index is defined as a portfolio of stocks that represents a particular market or market sector. Most major
economies as well as developing economies have at least one financial index. For instance, the Dow Jones Industrial Average (DJIA), one of
the most frequently used indices worldwide – is comprised of stocks from 30 of the largest companies in the US, representing approximately
25% of the US market. Meanwhile, the S&P 500 index is comprised of 500 of the most widely traded companies in the US, and represents
approximately 70% of the total financial value of the US stock markets. As the S&P 500 is more diverse than the DJIA, it can give a better
representation of the condition of US stock market as a whole.
The value of an index is usually described in terms of a number of points. Each index is calculated in a slightly different way,
but its value generally represents a weighted average of the current values of its component stocks. This means that the
changing value of an index from one day to the next reflects the fluctuating values of the individual stocks that it is made up of,
and is why an index can be a good representation of the state of a country’s economy or of a specific industry.
TIP: to trade indices, traders can go long on a particular index if they believe that stocks in that market are likely to increase overall in the
future, or go short on an index if they predict that the index is likely to drop in value.
UNDERSTANDING AN INDEX’S COMPONENT STOCKS
Popular Financial Indices
Understanding the stocks that make up an index can be an effective way of analysing an index. Different indices can have a particular focus
on certain types of stocks or market sectors. For example, the NASDAQ index mostly consists of technology stocks and so can generally be
seen as a measure of the performance of the technology industry (although the NASDAQ also lists various stocks from other industries, for
example, the finance, insurance and transportation industries). Monitoring indexes and noting their movements over time can help inform
traders about investors’ attitudes towards a range of companies and market sectors. Some widely traded indices include:
- The S&P 500 and Dow Jones (New York City)
- The FTSE100 (London)
- The DAX30 (Frankfurt)
- The Hang Seng (Hong Kong)
- The Nikkei 225 (Tokyo)
- The Shanghai Composite
Many multinational corporations have their stocks listed on an index other than their domestic exchange. This is referred to as cross-listing.
This means that when a firm’s domestic index is closed, its stocks may be tradable on an international index that is open. Cross-listing can
increase the liquidity of a company’s stocks, as it enables traders to choose from a range of markets from which to trade a particular share.
For example, Alibaba.com is listed on Hong Kong’s Hang Seng index as well as the New York Stock Exchange.
ROLLING DAILY AND FUTURES
Financial indices can be traded in ‘rolling daily’ format or as ‘futures’. Rolling daily trading is a trading format in which trades are “rolled over”
from one day to the next. A trade of this kind will stay open until the trader decides to close their position, or when their stop-loss order or
stop-limit 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 format means that traders are given or can choose a fixed expiry date and time at which their position on a security will
automatically close. In contrast to rolling daily contracts, futures trading does not attract overnight fees.
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