Your guide to the S&P 500

Those looking to trade have most likely heard of the S&P 500, but do you know why it is important or what value it has to traders? This article will provide an in-depth look at the S&P 500 that answers these questions and more.

What is the S&P 500?

Formaly known as the Standard & Poor’s 500, it is a stock market index tracked by the financial services company Standard & Poor’s. There are many different stock market indices, such as the US 500, Standard & Poor’s 500, Dow Jones, FTSE 100etc, that each aim at providing a general assessment of the state of the market.

They are typically a composite of selected stocks deemed representative of a market or industry and are used to track the rise or decline of the market as a whole. Each stock market index can differ not only in the stocks they track but also in the methodology used.

There is no standard for developing stock market indices, but traders can find them useful for providing financial insights and making broad analyses of markets and industries as a whole. They can also be used to develop funds pegged to the companies tracked in a stock market index.

Which companies does the S&P 500 track?

Since the S&P 500 is generally used as an indication of the health of the entire U.S market, its components come from a wide variety of different industries. It tracks the common stocks issued by 500 large-cap US companies. A combination of selection criteria and stock performance is used to determine which 500 companies make the list.
Standard & Poor’s provides a comprehensive criteria but to give a broad overview, a company must meet the following requirements:

A market cap of $5.3b or more
Be headquartered in the US and publicly trade its stocks on one of a selection of US stock exchanges
Must trade at least the value of its market capitalisation annually
Must public float at least 50% of its stock
Must have had its IPO at least 6 months ago
Must have had 4 straight quarters of reported growth

The S&P 500 is adjusted on an as-needed basis, meaning that there is no specified schedule for additions or removals.

As of the time of writing the top 5 stocks are:

Apple Inc. (AAPL)
Microsoft Corp (MSFT)
Exxon Mobil Corp (XOM)
Amazon.com Inc (AMZN)
Berkshire Hathaway B (BRK.B)

How is the value of the S&P derived?

The S&P 500 index is weighted by free-float market capitalisation, which means only the shares made publicly available are counted for each company. The sum of the market capitalisation is divided by what is referred to as a divisor. This number is proprietary, but is understood to be about 8.9 billion.

How can you trade the S&P?

There are several instruments available to trade the S&P 500. Since the S&P 500 is a stock index, you can’t trade it directly (unless you buy all the stock in the index at the exact ratio used to calculate the index).

Instead, there are two easier methods of trading the S&P index, using CFDs, or contracts for difference, is one such popular instrument. Essentially traders speculate whether the value of the S&P 500 will rise or fall within a specified time period and place trades accordingly with a CFD broker like London Capital Group.

The advantage of trading with a CFD broker is they don’t typically charge commission for trading indices and they allow you to trade on leverage. Since you don’t actually technically own anything when you trade on the S&P 500, you aren’t charged stamp duty tax on your trades either.

For example, LCG offer traders the US 500 to trade the S&P 500. They offer a minimum spread of 0.8, minimum trades from 0.1 lot and a margin requirement of 0.20%. This means at the current value of the S&P Index of 2,380, a trader would need a minimum account size of $238 to open a $11,900 position.

2,380 *0.1 (min lot)*$50 (value per point) = $11,900
$11,900*.002% (margin requirement) = $238

*Example is for illustrative purposes only. All information collected from https://www.lcg.com/uk/, see website for full terms and conditions. Your capital is at risk. Last updated on February 27, 2017.

Another popular trading strategy, though not unique to the S&P 500, is trading on index funds. Index funds mirror the selected stocks in each fund with the aim being that investor results match the performance of the index. These are typically attractive investment opportunities for investors who do not actively manage their investments, because they provide broad market exposure with low operating expenses.

Returns are usually quite modest but they are considered to be among the safer option for the risk averse, often beating out smaller, more actively managed funds in the long term. Pay close attention to funds offering this, as a fund which is properly weighed and tracked against the S&P 500 can be expensive – an amount of shares of each of the 500 companies equivalent to its free float market-cap must be purchased to genuinely track the index and there are very few investment funds with large enough capital to achieve both that goal and provide adequate liquidity for investor withdrawals.

Summary

For traders with a smaller account size or who want to use leverage for trading, a CFD broker could be the best choice, but you should always keep in mind that leverage works both ways and can amplify profits as well as losses.