What is a stock index? This is the most commonly traded and held asset in the stock market, by investors and traders alike. Have you heard of the S&P 500, the Dow Jones, the Nasdaq, maybe even the Nikkei 225? If these are common terms then you already know what people are referring to when using this! A STOCK INDEX!
An index simply put is a basket of stocks compiled to track the general movement of an economy, or an economies largest publicly traded companies. There are two general types of indexes, those that track the broader market, which are called broad-based indexes, just like the S&P 500 which tracks 500 different companies in different sectors. Then there are the more secular indexes that specialize in a specific industry, sector or segment of the market just like the Dow Jones industrial average.
The broader market index, the S&P 500 has been commonly linked to the overall US economy, it is affected by everything that the US economy is affected by and moves in peaks and troughs as well. When the economy is expanding so is the index, when its contracting so is the index, and it’s adjusted for the sectors within.
The index can be affected by the following:
- Interest rate changes/monetary policy
- Inflation, supply, and demand
- Supply chain issues, manufacturing output
We saw the index shift a lot into the end of 2021 and the beginning of 2022 when we had massive inflation concerns due to all the money the Federal Reserve was moving into the market due to the pandemic. A lot of quantitative easing printed a Feb 2022 CPI inflation reading of 7.9% year over year. The highest in 30 years. The market has been dropping ever since inflation fears rose as general prices of goods and services get more expensive. All while the wages stayed stationary.
They get affected by monetary policy as well, in low rate environments, we have expansionary movement because of cheaper borrowing costs. In higher rate environments we have tightening movement and drops due to more expensive borrowing costs.
Overall the index serves as a benchmark that portfolio managers and investors base their portfolio returns on. So why not just invest in the index itself rather than trying to find something that would beat it? Well, that is what we call indexing where you can passively buy the index and track your portfolio with the index. In this case, you can buy the SPY which is the S&P500 ETF. There are a lot of ETFs out there that track the index, some cheaper than others. The cheaper counterpart is VOO. You cannot directly invest in an index, but rather the ETFs.
Each market has an index that is used as a benchmark, bonds (Bloomberg US Aggregate Bond Index), stocks (S&P500), etc.
What Sectors & Stocks Do Our Broad-Based Indexes Hold?
Since we’re talking mainly about US equity indexes, let’s talk about the S&P500 and the Nasdaq 100.
Each of these indexes holds a different number of stocks and different weights of sectors. As of March 18, 2022.
The main sectors in the S&P500 and their weights are:
- Technology 27.46%
- Health care 13.86%
- Consumer Discretionary 11.82%
- Financials 11.58%
- Communication services 9.39%
- Industrials 8.02%
- Consumer Staples 6.08%
- Energy 3.82%
- Real Estate 2.70%
- Utilities 2.67%
- Materials 2.60%
Some of the biggest names in the S&P500 are the following (As of March 18, 2022):
- AAPL 6.69%
- MSFT 5.93%
- AMZN 3.67%
- GOOGL 2.15%
- GOOG 2.01%
- TSLA 1.897%
- BRK.B 1.69%
- NVDA 1.656%
- FB 1.316%
- UNH 1.278%
The Nasdaq 100:
- Technology 51.02%
- Consumer Services 16.55%
- Consumer goods 8.09%
- Health care 7.99%
- Financials 7.69%
- Industrials 5.50%
- Energy 1.02%
- Telecommunications 0.84%
- Utilities 0.81%
- Basic materials 0.51%
Some of the biggest names in the Nasdaq are the following (As of March 18, 2022):
- AAPL 12.18%
- MSFT 10.285%
- AMZN 7.25%
- NVDA 4.01%
- GOOG 3.95%
- TSLA 3.92%
- GOOGL 3.73%
- FB 3.357%
- AVGO 1.929%
- COST 1.853%
Investing in Indexes
As we mentioned above, you cannot directly invest in an index, rather you can invest in ETFs or Exchange Traded Funds that replicate the index. There are a lot of ETFs that replicate indexes, some better than others.
Each of these ETFs has a management fee if you are looking to hold it long-term, now the management fees are typically under 0.10%. If they are not, look for another ETF. However, some of the lower fees are between 0.03% and 0.05%. Those are the ones that you would want to look at and hold if you are investing in the index.
The largest and most common is the S&P500 index, the ETF counterpart is the SPY.
However, with a relatively large management fee of 0.09%, we would opt-in for the Vanguard counterpart VOO 0.03%. These are also called expense ratios.
This is where compounding comes into play as investors. All investors want to see their money grow and indexing is a cheap way to do it. Rather than paying a fund manager to lose to the index, a lot of investors pick up indexes or sectors through ETFs. A wise investor once said, “it’s not about timing the market, it’s about time in the market”. Which is great, but you can also time the moves of the market of where to add rather than continuously buying tops. Which we will talk about in the section below.
Trading indexes can be done in a variety of different ways, at TRADEPRO Academy we do just that.
You have the option to trade the ETF or CFD shares, or you can take another route and trade and learn the derivatives of the index.
SPY has shares traders can trade, on margin, considering they’re over $400. Then you can also trade the SPX CFD, which is a different denomination than just shares. We however prefer derivative assets that offer more leverage, high potential for gains, and much more.
The derivative assets you can trade indexes with are options & futures.
TRADEPRO Academy trades both live with our team each morning on Zoom and in our discord.
Options traders, we focus on the S&P500 index and the Nasdaq Index, which can be traded with the following instruments:
SPY, QQQ ETF & NDX, SPX CFD.
Futures traders focus on the S&P500 and the Nasdaq through the E-mini futures ES and E-mini futures NQ respectively. There are also micro contracts for each of the E-minis mentioned which are 1/10 of the contract size and price of the mini’s which allows traders to trade smaller and learn without having to invest a large bankroll in their trading to start.
Trading these derivative assets to trade indexes can be done on a day trade basis (options & futures) or on a swing trade basis (options).
The main tools used to trade the indexes are technical analysis and order flow. Take a look at the image below of the S&P500 futures E-mini. On the ledge side is DOM (depth of market) which is the primary order flow tool. On the right side is the chart where we can perform technical analysis.
If you want to learn more about futures, options, and index trading you can either check out our options room or our futures room.
If you want to join with us in our live trading room, Check This Out.
The information contained in this post is solely for educational purposes and does not constitute investment advice. The risk of trading in securities markets can be substantial. You should carefully consider if engaging in such activity is suitable for your own financial situation. TRADEPRO AcademyTM is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.