Index trading can be a great way to diversify your portfolio with a single trade, while gaining exposure to an entire market segment. In fact, stock indices are believed to be powerful indicators of the health of the global economy, as well as country-specific economies. They are also considered indicators of market sentiment and overall risk appetite.
Did you know?
The US stock market alone has about 5,000 indices. Of these, the Wilshire 5000 includes all the stocks listed on the US stock exchanges.
The most widely traded stock market index globally is the Dow Jones Industrial Average, which lists 30 of the largest stocks in the US. But there are two other US indices popular among traders globally, the S&P 500 and the Nasdaq Composite Index. Here’s what you need to know about these three most popular indices.
The DJIA was first introduced on May 26, 1896, by Dow Jones & Company, one of the largest business and financial news companies in the world. When it was launched, the index consisted of 12 stocks from the industrial sector. Today, it lists 30 of the largest and best-known stocks in America. It is a price-weighted index, which means that stocks with higher share prices carry greater weight than stocks with lower share prices on the DJIA.
Despite listing only 30 stocks, compared to the over 10,000 stocks listed on the US stock exchanges, the Dow Jones offers diversified exposure to multiple sectors of the American economy. The only exceptions are transportation and utilities, which are represented by the Dow Jones Transportation Average Index and Dow Jones Utility Average Index, respectively.
Did you know?
Some of the biggest blue-chip companies are included in the DJIA, including Apple, Coca-Cola, Intel, Microsoft, UnitedHealth Group, Goldman Sachs and Walmart.
Introduced in 1971, the Nasdaq Composite is a market cap-weighted index that includes over 3,700 stocks listed on the Nasdaq Stock Exchange. Being market capitalisation weighted, stocks with higher market caps tend to have a larger impact on the performance of the overall index, as compared to stocks with lower market caps. Unlike the DJIA, the Nasdaq Composite lists all types of equity securities, including ordinary shares, common stocks, American depositary receipts (ADRs), REITs and publicly traded partnerships. However, it does not list exchange-traded funds (ETFs), closed-end funds, preferred shares, warrants, rights, convertible debenture securities, or other derivatives.
Also unlike the DJIA, it lists companies that might have headquarters located in other countries.
The unique feature of this index is that it is a tech-heavy one, with the technology sector accounting for 51.11% of the stocks listed on it, as of April 2022. Some of the other sectors represented on the index are consumer services, consumer goods, healthcare, financials, industrials, and oil and gas.
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Five mega-cap companies account for over 40% of the Nasdaq Composite’s weight, led by Apple Inc. (AAPL) at 12.25%, as of March 31, 2022. Other prominent names listed on this index include Microsoft, Amazon, Meta Platforms and Alphabet.
The Standard & Poor’s 500 (S&P 500) index includes the top 500 companies listed on the NYSE and Nasdaq. Although several factors are taken into account while listing stocks on this index, market cap is one of the most important. The index gets its name from the credit rating agency that launched it in 1957. Given the diversity and depth of sectors represented on the S&P 500, it is considered one of the best gauges of the performance of American equities and the overall stock markets.
The top three sectors represented on the S&P 500 are Information Technology, Health Care and Communication Services, accounting for about 50% of the index. Of the three indices listed in this article, the S&P 500 offers the most diversified exposure, since almost all sectors of the economy and both US stock exchanges are represented on it.
Did you know?
The 500 companies listed on the S&P 500 account for almost 80% of the total value of the US stock market. Some of the prominent names on this index are Berkshire Hathaway, Nvidia, Amazon, Tesla and Meta Platforms.
The easiest and most popular way to trade indices is through Contracts for Difference (CFDs). This is a derivatives instrument that allows you to trade both rising and falling markets. With CFDs, you also gain the advantage of leverage trading, which allows you to gain much larger exposure to the market than you could with the capital in your trading account alone. However, remember that while high market exposure can enhance your profit potential, it can also magnify potential losses. This is why experienced traders recommend practising on a demo account to build your trading strategy and skills before investing your hard-earned money in the live markets.
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