The global financial market has become increasingly diverse and lucrative over time, with a variety of asset classes and investment vehicles now available to traders.
Indices trading is particularly popular in the current market, although this is an easily misunderstood term and one that some investors fail to capitalize on fully.
In this post, we’ll take a closer look at what it means to trade indices while considering how such entities are calculated.
What is Indices Trading?
In simple terms, indices trading enables you to take a position on a particular stock index, rather than investing in a single share or equity.
This automatically minimizes your market exposure and risk as an investor, while providing natural diversification across different industries, markets, and even countries.
This type of investment is also speculative, which means that you can potentially profit from rising or even falling indices without assuming ownership of the underlying asset or instrument.
Indices themselves provide a measure of the performance of several different companies, with some investors also utilizing them to inform standalone investments in specific equities. However, they retain value as diverse and balanced investments and by offering an insight into targeted markets and assets across the globe.
How are Stock Market Indices Calculated?
There are numerous types of indexes, including world-renowned options like the S&P 500, the FTSE 100, and DAX 30 (the latter of which features the 30 largest and most seminal companies in Germany).
Not all of these indices are created equal either, as there are different ways of calculating such assets and determining an investor’s value proposition.
In most cases, stock market indices are calculated according to the market capitalization value of their component companies, with this methodology affording far greater weighting to larger cap firms and creating a more accurate gauge of performance overall.
Popular indices such as the S&P 500 are calculated in this way, as are the FTSE 100 and Nasdaq 100.
Conversely, similarly popular and well-known indices such as the Dow Jones Industrial Average (DJIA) are actually price-weighted, with this giving a greater weighting to companies with inflated share prices.
This creates a more volatile investment option for speculators, as any changes in individual stock values will have a far greater effect on the real-time price of the index in question.
The Last Word
The last point is particularly interesting, with the volatility of indices offset by the ability of investors to speculate on performance and profit even as market conditions worsen.
Like individual stocks, indices price movements and volatility are impacted by factors like macroeconomic changes and political events, which may target specific countries and markets more than others.
It’s important to bear this in mind so that you can make informed decisions as a trader and leverage an index’s innate volatility to your advantage.
