What are stock market indices and why are they needed?
What are stock market indices? This is an indicator of changes in the prices of a certain group of securities. It is possible to imagine a stock index as a “basket” of shares, united on some basis.
The most important thing, when studying market indices, is what stocks or bonds they are formed of. It is the set of securities included in the list. Based on which the index is calculated, that determines what information can be obtained by observing the dynamics of these stock market indices. Note that if your trader wants to work with cryptocurrency, no indexes have been invented for cryptocurrency yet.
Why do we need market indices?
Generally speaking, the main purpose of stock indexes is to create an indicator that can be used by investors to characterize the general direction and “speed” of movement of stock exchange quotations of companies in a certain industry.
Studying the dynamics of indices helps stock exchange participants understand the influence of certain events on quotations – if, for example, oil prices increase, it is logical to expect the growth of quotations of all oil companies.However, shares of different companies grow at different rates (and some may not grow at all) – the index helps to understand the general movement trend of the market segment without the need to evaluate the position of many disparate companies.
Comparison of indices gives an understanding of how different sectors are traded in the market in comparison to each other.
Classification of stock market indices
There are many stock market indices, which are created to solve specific tasks. These instruments are classified according to different features – method of calculation (weighting of components), families, and author. Let’s consider each type of index in order.
Families of world market indices
Above we have repeatedly used the phrase “index family”. Really, some index creators do not limit themselves to one index, but create the whole family of similar instruments.
One of the most popular indices are those calculated by the Standard & Poor’s (S&P) rating agency. They include the main index S & P 500, which unites the 500 most capitalized companies in the United States (80% are traded on the NYSE, 20% – on the AMEX). NASDAQ has its own family of indices – these indicators consider the behavior of more than 4,500 American and foreign companies. These include the NASDAQ Composite index (which unites all companies listed on the exchange), the NASDAQ National Market (companies from the US), as well as a mass of industry indices.
In Europe, a notable family of indices are German stock market indices (DAX 30, Dax Price Index, DAX 100, Sector Indexes, etc.) and French CAC, which differ by the number of included stocks (40, 80, 120, etc.). Financial indices charts show the economic situation.
Another way to classify indices is by distribution according to their compilers. Indices can be “agency”, when they are calculated by special agencies (for example, Standard & Poor’s S&P indices). The second variant is stock indices created by the stock exchanges themselves. Also, the compiler of indices can be a brokerage company. And do not forget that US stock futures investing is always a risk.
What current stock market indices show
The list of shares, the quotations of which are used for forming indices, is formed according to certain criteria, depending on the purpose of compiling a particular index.
The index calculation method implies the inclusion of financial instruments with similar characteristics. In particular, the share capital of companies whose shares are considered in the index should not differ by orders of magnitude.
In general, it is believed that the movement of stock quotations of well-known and large companies reflects the trading dynamics of smaller financial instruments from the same industry (this is an important clarification). The branch exchange indices are needed to create hypotheses about price movements of different companies of the same branch, even those that are not included into the index itself. Correspondingly, industry indices help investors evaluate the prospects of investing in companies in this or that sector of the economy at a particular moment in time.
How to use indices for investing futures
In general, the existence of stock market indices today serves several purposes. They can be used for:
- To get an idea of the general dynamics of share prices of a certain group (companies, countries, industries, etc.). Often, this data is used for speculative trading.
- There are derivative instruments based on the index itself – for example, there is an investing futures market for the RTS Index. Most often such contracts are used to hedge the risks of investing in futures indices.
- Getting information about changes in investor sentiment – if indices are increasing, it means that investors look positively on the prospects of investments in certain stocks.
- Watching US stock market indices over a long period gives an idea about the investment climate of US futures investing.
- Often, apart from the value of the major market indices themselves, information is published about the total turnover of the shares of its members. The change of these figures lets us judge about the general activity of the market traders in the transactions with the securities of a certain type.
If you are looking for information about what are futures in investing, remember that it is a very high-risk asset. There are dozens, if not hundreds, of various indexes created and actively used all over the world. Any of these instruments can be useful and perform a certain task. The most important thing – to use the major market indices, you need to know based on what shares they are calculated. Then it is possible to analyze the dynamics and understand the information that a particular financial index carries today.