What is a Stock Market Index?
A stock market index is a measurement of an established segment of the stock market. It is often used as a type of benchmark from which the performance of other stocks is measured and is used by investors as a gauge for building a portfolio. For example the FTSE 100 is made up of the biggest 100 companies on the London Stock Exchange and provides a meter for the UK markets whilst the DAX index is made up of 30 of the top companies listed on the Frankfurt Exchange and is a meter of the German stock market.
The value of an index at any point in time is determined by the combined prices or combined capitalisation of stocks within that particular index. The index may be either a price weighted average or a market weighted average of all the stocks included in the index.
Each index essentially serves as a tracker of the overall performance of a particular portion of the market.
The Most Traded Stock Market Indices
Although there are many stock market indices, there are a few that are more regularly traded across the financial markets. Some of these indices are:
- The Dow Jones Industrial Average – Commonly referred to as “the Dow”, this index includes stocks of the top 30 companies in the United States in terms of size and influence. The Dow is price weighted which means that it derives its value from the weighted average of the prices of these 30 stocks. The value of the Dow represents approximately 25% of the value of the US stock market.
- The S&P 500 Index – This index is the Standard and Poor’s 500 index and it is a portfolio of the 500 most traded stocks in the US stock market. Since the value of this index represents as much as 80% of the US stock market, it gives a good indication of the performance of the entire stock market. The S&P 500 is market-weighted rather than price weighted. The value, therefore, depends on the market capitalisation of the relevant stocks included.
- The Wilshire 5000 index includes stocks of almost every publicly-traded company headquartered in the USA. Because of this, it is also referred to as the “total market” index.
- The Nasdaq Composite Index – This index is more specialised than the others because it is comprised solely of technology stocks. It is market-weighted and includes all the stocks that are traded on the Nasdaq stock exchange. Not all stocks in the Nasdaq, are of companies that are headquartered in the US.
Advantages and Disadvantages of Trading Indices Through CFD Trading
Stock market indices are often traded through CFD trading. Trading indices via CFDs will allow the trader to trade on margin and to benefit from leverage. This means that the trader may purchase a certain number of contracts with a smaller account size, compared to what would be required to purchase each individual stock included in the index.
CFD brokers often offer margin to trade indices such as London Capital Group who offer margins as low as 0.20%. In addition to trading with leverage, a trader can both buy and sell contracts, giving the opportunity to benefit regardless of how the market is moving. Below are some of the trading conditions for Index futures with London Capital Group. For more details visit the LCG website.
|Market||Min Spread||Min trade size||Value of 1 point/lot||Guaranteed Stop charge||Margin required|
|Wall Street||5||0.1 lot||$10||4||0.20%|
|Germany 30||3||0.1 lot||€10||4||0.20%|
|US 500||0.8||0.1 lot||$50||0.8||0.20%|
|US Tech 100||2||0.1lot||$100||0.8||0.20%|
|France 40||4||0.1 lot||€10||4||0.40%|
|Japan 225||15||0.1 lot||$5||10||0.40%|
*All information collected from https://www.lcg.com/uk/, see website for full terms and conditions. Example is for illustrative purposes only. Your capital is at risk. Last updated on February 1, 2017.
Another advantage of trading indices with a CFD broker like London Capital Group is that they usually do not charge a commission on the trades. The broker instead makes their profit from the spread.
One of the advantages of trading indices through CFD trading is also a disadvantage. Traders who decide to take advantage of the margin offered by brokers will have increased the upside when the trade goes in favour of the trader, however, the risks will also be magnified if a trade goes against them. Traders should therefore not trade more than they can afford to lose since they could lose 100% or more of their original investment.
Stock market indices are a statistical representation of a portion of the stock market. They may be price weighted or market-weighted and often act as benchmarks of the performance of the market. A stock market index may be traded through CFD trading which may magnify returns, but which may also magnify the risks.