In this overview, we will discuss stock indices. They are popular instruments that reveal the current situation in the stock market, used by traders and investors for trading in financial markets.
What are indices?
Stock indices demonstrate the price dynamics of a certain set of stocks in an exchange. The stocks of selected companies comprise a group, for which an index is calculated by a certain method. For example, the FTSE 100 index tracks the dynamics of the 100 largest companies in the London stock exchange. With indices, you access whole sectors and branches of the economy at once, having just one position open.
Indices demonstrate the development of the economy: many economists and investors use indices to assess the situation in the economy of a country. If stock indices grow stably, this means that the economy is developing, and the investment climate is good. If stock indices start falling, the economy is in trouble, and buying indices might be dangerous.
How are indices calculated?
Most stock indices are calculated based on the capitalization of the companies they are comprised of. This method makes companies with a larger capitalization more influential, i.e. their performance will affect the final values of the index more than that of companies with low capitalization.
However, certain popular indices, such as the Dow Jones Industrial Index (DIJA) use a weighted method of calculation. This makes companies with a higher stock price more important, and changes in their stock price will affect the current price of the index. The list of companies included in the index can be reshuffled from time to time.
In financial markets, so-called “standard indices” are the most influential. These are the leading stock indices that investors base their decisions on. These indices are trustworthy indicators of the economic health of a certain country or region. 6 most popular indices would be:
1. Dow Jones (US 30) reflects the weighted stock price of the 30 largest US companies. This is the oldest stock market that has ever been calculated and used for trading.
2. DAX (GER 30) tracks the stock price of the 30 largest joint-stock companies of Germany traded in the Frankfurt Stock Exchange.
Be sure to check out How to Trade DAX 30 article.
3. NASDAQ 100 (NAS 100) evaluates the market price of some 100 largest high-tech companies in the USA.
If you want to find out more about Nasdaq 100 and How to Invest in Indices, make sure to check out this article.
4. FTSE 100 (UK 100) unites the 100 largest companies quoted in the London Stock Exchange.
5. S&P 500 (US 500) is the so-called “wide market index” that tracks the price of 500 companies with a high capitalization in the USA.
If you’d like to read more about investing in S&P 500, check out this article.
6. Nikkei (Japan 225) is the main stock index of Japan that consists of the 225 largest Japanese companies.
For more, check out How to Trade Nikkei 225 article
What does influence the quotations?
The quotations of stock indices are influenced by a whole range of factors; the most important ones would be:
- Macroeconomic events: the general state of the economy, decisions of Central banks about credit and monetary policy, GDP and inflation data, etc.
- Political events: elections, resignations of governments, speeches of national leaders;
- Financial performance of the companies: profits and losses of certain companies increase or decrease their stock prices, which might be reflected in the index values;
- Corporate events: reshuffling of the management, various mergers influence the stock prices, which, again, might cause a positive or negative effect on the stocks;
- Changes in the contents of the index: the quotations of weighted indices might change if companies are added to or deleted from the index because investors correct their positions with regard to the new list of stocks.
How to trade indices?
For more profound information check out our post about trading indices with strategies.
This must be the simplest way to trade indices. The main idea is to wait for a correction and buy the index at the beginning of a new wave of growth, counting on subsequent renewal of the highs. This is a simple strategy but you have to be patient for the profit to reach the planned levels. For long-term investments, various ETFs are frequent favorites.
Here, we imply medium- and short-term trading, where positions are held for a limited time. As a rule, leverage is used. Decisions are mostly made based on tech analysis. Support/resistance levels, price patterns, candlestick combinations, Price Action patterns, signals from indicators — these and other instruments help to find trading opportunities.
Stock indices are not only indicators of the economic development of countries and regions but also popular trading instruments. Special financial instruments (futures, CFDs, ETFs) allow for different types of trading: both long- and short-term. The choice depends on your preferences, just make sure you are controlling risks.
By Dmitry Gurkovskiy, Chief Analyst at RoboForex