The world’s stock markets maintain a number of “indexes” for the shares that make up each market. Each index represents a specific segment of the industry, or the wider market itself. In many cases, these indexes are trading tools themselves; this feature is called “Index Trading”. The index represents the aggregate picture of the companies that make up the index (also known as the “components” of the index).
For example, the S&P 500 Index is the broadest market index in the United States. The components of this index are the 500 largest companies in the United States by market capitalization (also called “Large Capital”). The S&P 500 Index is also a trading instrument in the Futures & Options markets, trading in the SPX symbol in the Options market and և / ES in the Futures markets. Institutional investors as well as individual investors and traders can trade with SPX ES / ES. SPX is only traded during regular market hours, but / ES is traded almost 24 hours a day in futures markets.
There are several reasons why index trading is so popular. Because SPX or / ES represents the entire microcosm of the S&P 500 index of companies, the investor is instantly acquainted with the entire basket of stocks that represent the index when buying SPX 1 or futures և / ES contracts. accordingly. This means instant diversification for the largest US companies built on the convenience of a single security. Investors are constantly looking for portfolio diversification to avoid the volatility of holding just a few shares of the company. Buying an index contract is an easy way to achieve this diversification.
The second reason for the popularity of the index trade is due to the self-designed horse. Every company in the index has a certain relationship with the index when it comes to price movements. For example, we can often see that as the index goes up or down, most component stocks also go up or down in a very similar way. Some stocks may rise higher than the index, and some stocks may fall higher than the index in the event of similar movements in the index. This ratio between the stock և its parent index է is a beta of the stock. Looking at past stock-to-stock price ratios, the beta of each stock is calculated and available on all trading platforms. This then allows the investor to protect the stock portfolio from losses by buying or selling a certain number of contracts in SPX or / ES instruments. Trading platforms have become complex enough for your portfolio to instantly “beta” to SPX և / ES. This is a great advantage when a wider market crash is imminent or already underway.
The third advantage of index trading is that it allows investors to see the “macro point” of the markets in their trading-investment approaches. They no longer need to worry about how individual S&P 500 companies work. Even if a very large company is in trouble in its business, the impact that this company would have on the broad market index is weakened by the fact that other companies can do well. This is exactly the effect that diversification should have. Investors can adapt their approaches based on broad market factors rather than individual company nuances, which can be very difficult to follow.
The downside of index trading is that broad market returns are usually averaged from average to high single digits (average about 6 to 8%), while investors can earn much higher returns from individual stocks if they are willing to resist. instability combined with the possession of individual stocks.