If you have ever invested in the share markets, then chances are high that you have heard about words such as “the markets have fallen” or “the markets have risen”. But whenever you try to compare falling and rising with your portfolio, there’s nothing much. That begs the question, how did the markets rise or fall?
What Are Indices?
Simply put, indices are a measure of a group of shares from an exchange with regard to price performance.
Why Do People Trade Indices?
Trading indices give investors an opportunity to familiarize themselves with the whole sector or economy at once by opening just one position.
As a trader, you can speculate on the price of indices falling or rising without necessarily assuming ownership of the underlying asset. The good thing about indices is that you can trade for longer hours compared to other markets.
Here are some of the things you need to know about index trading:
1.Methods of Index Construction
For you to get the most out of index trading, you need to understand how an index is constructed. For any company to be included in the index, there is a certain criterion that it should meet and maintain that criteria if it doesn’t want to be replaced with another stock.
After being included in an index, the company is issued with a particular weightage. It is this weightage that determines a company’s ability to regulate the index using that percentage. Weightage is allocated through a method called free-float market capitalization.
2.Index Trading vs Share Trading
Trading indices offer you an opportunity to know the companies that are in the index. For instance, if one is trading in the S&P BSE index, then they are free to invest in any of the 30 companies in the index.
Conversely, share trading only gives you an opportunity to invest in the shares of one company. This means you don’t have any other business with the stocks of other companies available in the market.
It is a fact that index trading can be very risky compared to other forms of investments. This is because it comprises the stocks of the largest companies in the entire market – making it highly volatile and speculative.
According to reputable places like Capital.com, other than the risk factor related to price fluctuation, indices trading needs a great deal of money because you are investing in the biggest companies in the market.
4.Factors That Affect the Valuation of Indices
Trading indices requires investors to properly understand how those indices are valued in the market. Any smart investor should have basic knowledge with regards to the valuation as well as factors influencing an index.
Some of the common factors that affect the values of the stocks of an index include geopolitical factors, GDP and inflation rate, internal business factors among others.
Index trading offers a lot of opportunities to investors. Those who are able to master how it works have the potential of reaping big. Although it requires some good money to invest, the returns are always good.