Indices trading
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What are indices?

 

Indices are baskets of securities, that represent a consolidated view of a larger picture. A tree does not describe the forest, as much as one healthcare stock does not describe the healthcare sector.

 

When a group of securities is bundled together and averaged to a single value, we get a performance indicator of what this group represents. Representation could be of the security type, a specific sector, a country or a broader regional area.

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The creator of an index asks

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National Indices

S&P 500, CSI 300, HANG SENG 75, FTSE 100, ASX 100, NIFTY 50, DAX 40

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Regional Indices

EUROSTOXX 50, S&P Asia 50, S&P Latin America 40, MSCI GCC 87

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Sector Indices

Indices that track sectors/industries of an economy (ex. NASDAQ Industrial, Telecom etc)

All about stock sectors

 

Companies that have similar products/ services are categorized under a specific sector

Is index trading a new concept for you? Visit our glossary for basic terms and definitions

trading terms

Components

Constituents

 

Individual members of an index.

In a stock index for example, a constituent is one of the companies listed.

Market value of constituents

 

Market Value = Share Price x Number of Outstanding Shares

Total market value

 

Sum of constituents market value

Base value

 

The starting value of an index. Every new value is then compared to the base value.

Divisor

Calculation depends on the index weight type.

 

  • Market cap weight | Divisor = Total market value/Base value
  • Price weight | Operator provides the divisor
  • Equal weight | No divisor

Weights

Market capitalization weight

Weight is assigned according to company size. The bigger the market cap, the bigger the weight.

 

  • Divisor = Total Market Value / Base Value
  • Index Value = Total Market Value / Divisor

Price weight

 

  • Divisor = Complex calculation – provided by the Index operator (example as of Nov 2021, the DJIA divisor is set to 0.15172752595384)
  • Index Value = Sum of Stock Prices / Divisor

Total market value

 

  • Divisor = No Divisor required.
  • Weight = 1 / number of constituents
  • Index Value = Sum of Stock Prices x Weight

Fundamentally weighted

 

More weight to constituents with better fundamentals (revenue, price-to-earnings ratio, cash flow, dividend payouts)

Weight of constituents = Value of the fundamental variable /  Sum of the values of the fundamental variable of all constituents

Rebalancing is done by committees

 

  • They set rules constituents must meet to be included
  • They meet regularly to review the index rules (quarterly or annually)
  • They decide to add / remove constituents
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Index types

Index trading hours

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Factors that affect index prices

POLITICS / GEOPOLITICS

National policies, global relationships

REBALANCING

Changes to the composition of the index

MACRO ENVIRONMENT

Economy and fundamental indicators

COMMODITIES

Commodity price fluctuations

MICRO ENVIRONMENT

Company fundamentals, earnings reports

SUPPLY / DEMAND

Volume, liquidity, buy/sell pressures

FORCE MAJEURE

Natural disasters, disease, pandemics

EXCHANGE RATES

Especially multinational companies

How to trade indices?

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Research and education is key

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