Hundreds of thousands of companies trade their securities on the stock exchanges. Indices come in handy when you have to track changes in the prices of countless securities and understand the market’s sentiments. Indices make it possible to assess the state of the stock market and to determine the current moment in the economic cycle.
Investors use stock indices to estimate the situation on trading platforms and predict future trading results. Indices are calculated for different countries, industries, or a certain group of securities: stocks, bonds, and other assets.
Indices are divided into groups according to their calculation methodology. Some of the most common are:
Arithmetic index. The market prices of the shares included in the index are added up, and the resulting sum is divided by the number of included shares.
Weighted average index. The calculation involves multiplying each number in the data set by a predetermined weight. In price-weighted indices, each company's stock is weighted by its price per share, and the index is an average of the share prices of all the companies. As a result, stocks with higher prices have a bigger impact on the movement of the index than those with lower prices. An example of such an index is the Dow Jones Industrial Average (DJIA). In capitalization-weighted indices, also known as market value-weighted indices, the weighting of a particular stock is determined by its total market capitalization. In such indices, stocks with a larger market cap have a higher weighting, and any movement in their share prices will have a larger impact on index performance. The Standard & Poor’s 500 (S&P 500) is the most familiar example of such an index.
Geometric average index. It is calculated from the growth rate of stock prices. This type of Index includes the FT 30 Index created by the Financial Times and the Value Line Composite Geometric Index.
In general, indexes have several purposes.
To get an idea about the general dynamics of stock quotations of a certain group (companies, countries, industries, etc.). Often, this data is used for speculative trading.
Getting information about investors’ attitudes. If indices increase, investors have a positive attitude toward investments in certain stocks.
Index monitoring over a long period gives an idea about the investment climate in a certain country.
In addition to the index value itself, information is often published about the total turnover of shares of its constituent companies. Changes in these figures indicate the overall activity of traders in the market in transactions with securities of a certain type.
The most well-known international indices that you can trade with FBS include:
NASDAQ 100 Index (US100),
FTSE 100 Index (UK100),
Nikkei 225 Index (JP225),
Australian Stock Index (AU200).
To choose indices for trading, you must first consider the factors that can affect the quotes. Namely:
Macroeconomic indicators. GDP, the level of industrial production, and trade balance. Even the levels of inflation and unemployment can have an impact on quotations. For example, an increase in unemployment in conjunction with other indicators may indicate a decrease in consumption followed by a decline in company revenues.
Economic and political events. US elections, military conflicts, sanctions, trade wars, and international trade agreements all affect the future profits of companies and, consequently, indices.
Traders’ sentiments. These are traders’ attitudes to market and economic prospects. The majority opinion plays a big role.
Index futures are a type of contract in which a stock index serves as an underlying asset. In other words, it combines the qualities of both a futures contract and a stock index.
Investors often use index futures for hedging, opening short positions against the stocks in their portfolios. The underlying assets are not the shares of a single company but of a number of companies, which means that the risk of a complete collapse is minimal. Even during the crisis, investors who hedged their portfolios with index futures emerged from the crisis with minimal or no losses.
In addition to hedging, experienced traders use index futures to speculate on an index’s price movement. This means that a trader buys or sells index futures to bet on the price direction of a group of assets.
Stock indices are not just analytical information. This is a full-fledged working tool with which you can make independent transactions, assess the state of the industry, and conduct fundamental market analysis. On top of that, index trading risks are always lower than investing in individual stocks.