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Lesson 10: Stock Indices

Lesson 10: Stock Indices

A stock market index measure the performance of a group of shares. Because there are no underlying physical assets to exchange, indices are traded with financial derivatives like CFDs.

Stock indexes are used as important benchmarks in measuring the returns of various assets such as the stock market. Index investing has become increasingly popular over the years, with this passive strategy outperforming more active investment over time, especially net of fees and taxes. While you cannot buy stock indices (which are just benchmarks), there are three ways for you to mirror their performance and invest in a stock index.

There is quite a bit you should know before you dive in. If you want to invest in stock indices right away, here is a quick guide:

  1. Decide how to invest in stock indices - The most popular include trading on the index’s value through CFDs.
  2. Select your stock index – With CAPEX.com you can choose from an offering of up to 20 CFDs on major global stock indices.
  3. Take your position - Create an account with us to start leveraged index trading.

For more info about how to invest in stock indices, you can discover everything you need to know in this guide.

What is a Stock Market Index

A stock market index is a compilation of stocks constructed in such a manner to track a particular market, sector, commodity, currency, bond, or another asset.

For example, the Dow Jones and the S&P 500 are the primary stock indices of the American markets. The constituents of both lists are companies listed on the New York Stock Exchange, NASDAQ, and other stock exchanges. Tadawul All Share Index (TASI) is a major stock market index that tracks the performance of all companies listed on the Saudi Stock Exchange.

Or, for example, a technology stock index will contain several or all technology stocks. The stock index then moves with the overall performance of the markets/industry/sectors that it holds within it. This index can then be quickly used to monitor how technology stocks are performing currently and over time.

Key things about stock indices

  • They’re an indirect way to get exposure to the whole market. Indexes are designed to track a particular market or asset.
  • By accepting defeat, you actually win. Picking individual stocks, you’re probably not going to outperform the market.
  • Stock Indexes are increasingly popular with investors. Most hedge-fund managers include stock indexes in their portfolios.
  • Stock Indexes are available across a variety of asset classes. Investors can trade indexes that focus on companies with small, medium, or large capital values or focus on a sector like technology or energy.
  • Individual stocks may rise and fall, but indexes tend to rise over time. With a stock index, you won’t get bull returns during a bear market. But you won’t lose cash in a single stock investment that sinks as the market turns skyward, either. And the S&P 500 has posted an average annual return of nearly 10% since 1928.
  • The stock indexes help diversify your portfolio. Stock Indexes spread risk around and give investors greater choice among conservative and riskier investments, as well as a broader mix of industries and asset classes. With index investing, you simply don’t put all your eggs into one basket.
  • Lower risks. Though indices can also be volatile due to factors like geopolitical events, economic forecasts, and natural disasters, an index losing or gaining 10% is already a huge historical event that will often hit the news.
  • No risk of bankruptcy. Unlike an individual company, an index can’t go bankrupt. If a US 30 constituent goes bankrupt, it is replaced by the 31st company in the list of leading American stocks (blue-chips). However, if you hold shares in this business, you’ll automatically lose your investment.
  • Stock Index has fewer fees than erodes your returns. The trading costs are lower for indexes since they require less work than managed accounts. You’re not paying for someone to study financial statements and make calls on what to buy.
    » Examine the cost: Open a demo trade account

How to Invest in a Stock Index?

Stock index investing is a passive investment strategy that seeks to replicate the returns of a benchmark index. It can only be accomplished indirectly, either through self-indexing, index derivatives, or index funds & ETFs.

1. Trade Indices Directly

If your brokerage account is set up for derivatives trading, another way to invest in a stock market index is through spot and futures contracts listed on the index.

Spot or cash trading is the method of buying and selling an index at the current market rate, known as the spot price.

Trading index futures means you agree to trade the index at a specific price on a specific date.

With us, you can trade the top stock indices directly and from a single position. You’ll do this by speculating on the index spot and futures prices using leverage derivatives like CFDs. You won’t own any company shares outright. Instead, you will get exposure to the stock index.

You can go long (buy) or short (sell) on the index price. You’ll put down an initial deposit (called margin) to open a larger position, with profits and losses calculated on the full position size, not your deposit. Note that this means your profits or losses could outweigh your deposit amount.

CFDs are commission-free when you trade stock indices with CAPEX.com, as charges are included in the spread.

Trade the major stock indices directly with CAPEX.com

  • Create a CAPEX.com account
  • Research the index you want to trade
  • Access the performance of the largest companies from a single position
  • Go either ‘long’ (if you think the price will rise) or ‘short’ (if you think the price will fall)
  • Trade commission-free indices with CFDs as charges are included in the spread
  • Take steps to manage your risk (position size, stop loss, take profit)
  • Monitor and close your position

2. Trade or Buy Shares

To try to replicate the stock index yourself, in a process known as indexing. This way, you can create your own portfolio of securities that best represents a stock market index, such as the Dow Jones. The stocks and the weightings of your allocations would be the same as in the actual index, and the information about index components and their percentage weights is publicly available on several financial or investing websites.

Adjustments would have to be made periodically to reflect changes in the stock market index. This method can be quite costly since it requires an investor to create an extensive portfolio and make hundreds of transactions a year.

It will take time and effort to construct the portfolio. It will also require a significant amount of transaction costs, as you will need to buy, for instance, 500 individual stock orders to capture the S&P 500. Commissions, in such a case, can really add up making it very costly to do.

To invest in an index 100 or even 500-constituent company, you’ll need to commit the full value of the shares upfront because leverage isn’t available. While you might need more initial capital to get started when compared to trading, your losses are capped at this amount. That said, you should be aware that you might get back less than your initial outlay.

You can also trade these companies without having to take ownership of shares, using CFDs. These are leveraged trades, so you can go long or short and open a trade by depositing only a fraction of the total value of your position. But, because your total exposure is greater than the deposit (known as ‘margin’), your losses could substantially outweigh this initial amount. When trading with leverage, it’s vital to take steps to manage your risk.

>> Learn more about stock trading

3. Trade or buy ETFs

An index ETF is one of the most effective ways to diversify an investment portfolio, thereby mitigating a portion of the risk of holding just a few, concentrated assets.

To invest in index funds either buy and sell an ETF just as you would do with any other security or speculate on the price movement of the underlying asset with CFD.

Buying shares in an index ETF is one of the most traditional ways for investors to gain access to the whole index. Index ETFs will either buy assets – e.g. stocks appearing in the index – or use derivative instruments like futures contracts to mimic the performance of the underlying.

Alternatively, open a position on an index ETF with a CFD and speculate on the collective performance of the US, UK, and EU’s top companies and sectors. The most common form of stock index ETF is a weighted tracker, which mirrors the make-up of the index directly.

Examples of weighted trackers include the SDPR Dow Jones Industrial Average and the SDPR S&P 500.

>> How to invest in ETFs

Why trade CFDs on indices with CAPEX?

  • Benefit from our deep liquidity – increasing the chance of your larger trades being accepted
  • Access both spot and futures prices with zero commission and leverage up to 1:20
  • Get spreads from 0.4 points on the US 500 index, and 1 on the US 30
  • Deal on our award-winning platform and mobile app with integrated tools
  • Give yourself an edge with the CAPEX Academy
  • Go short or long to capitalize on falling or rising markets

The most popular Global Stock Indices

US Stock Indices

The Dow Jones index (DJIA) comprises 30 prominent US stocks listed on stock exchanges in the United States: 3M, American Express, Apple, Caterpillar, Chevron, Cisco, Coca-Cola, DuPont, Exxon Mobil, General Electric, Goldman Sachs, JPMorgan Chase, Johnson & Johnson, McDonald's, Merck, Microsoft, Nike, Pfizer, Procter & Gamble, Travelers, UnitedHealth Group, United Technologies Corporation, Verizon, Visa, Walmart, and Walt Disney.

The S&P 500 measures the performance of 500 large companies listed on US stock exchanges. Some of these include 3M, Adobe Systems, Alphabet, Amazon, American Express, Berkshire Hathaway, Boeing, Citigroup, Coca-Cola, eBay Inc, Exxon, FedEx, General Motors, General Electric, Goldman Sachs, Harley-Davidson, Hewlett Packard, Hilton, Intel, Johnson & Johnson, JPMorgan, Mastercard, McDonald's, Nasdaq, Nike, Oracle, PayPal, PepsiCo, Salesforce, Starbucks, Twitter, Visa, Walmart and more.

The Nasdaq 100 contains the 100 largest companies in the technology sector in the US. Unsurprisingly, the Nasdaq is one of the global indexes that we hear a lot about and is highly regarded by stock index traders.

Some stocks represented by the Nasdaq 100 include Adobe, Advanced Micro Devices, Alphabet Inc., Amazon, Amgen, Apple Inc., Autodesk, Cisco, Citrix, eBay, Expedia, Facebook, Hasbro, Intel, Intuit, Marriott, Micron, Microsoft, NVIDIA, Netflix, Tesla, Workday, and more.

Asia-Pacific stock indices

Asian and Australian stock indices often aren't as popular with UK and US traders due to the different time zones in which these indices operate. However, for those who are open to unusual stock trading hours, or who are trading around a day job, they can provide some interesting opportunities.

The Nikkei Stock Exchange Index, also known as the Tokyo Stock Exchange Index or Nikkei Stock Average, consists of 225 companies and is the most important stock exchange index on the Japanese stock exchange.

Companies represented by the index include Canon, Casio, FujiFilm, Fujitsu, Honda, Mazda, Nikon, Nissan, Panasonic, Sapporo, Subaru, Suzuki, Toyota, Yahoo, Yamaha, and more.

When looking at Chinese markets, we should mention the Chinese index: the SSE Composite Index. The SSE Composite Index is the most widely used stock index in China, reflecting the performance of the Shanghai stock exchange.

Another Chinese stock index is the CSI 300. The CSI 300 is the Shanghai stock market index of the country's 300 largest companies by market capitalization.

These stock indices are sometimes referred to together as the Beijing stock index, referring to the country's capital, although the country's stock exchange is located in Shanghai.

A third Chinese stock market index, the FTSE China 50, features 50 companies chosen from the Shanghai Stock Exchange and the Shenzhen Stock Exchange.

Another popular Asian stock index is the Hong Kong HSI50 index. The Hong Kong stock market index comprises the country's 50 largest companies by market capitalization.

The S&P/ASX 200 represents Australia's 200 largest companies by market capitalization. These companies account for 82% of Australia's share market capitalization, meaning the ASX is one way you can trade on the state of the Australian stock market.

Companies listed in the ASX 200 include ANZ Banking Group, Blackmores, Commonwealth Bank, Coca-Cola Amatil, Caltex Australia, Domino Pizza, National Australia Bank, Qantas Airways, Telstra Corporation, Virgin Money, Westpac Banking Corp, Woolworths, Xero and more.

Middle East stock indices

The Tadawul All Share, or TASI, is a Saudi Arabian index. It measures publicly-traded companies on the Saudi Stock Exchange, also known as Tadawul. It is operated by the Capital Market Authority.

The index was launched in 1985 with a base value of 1,000 and was restructured in 2008. The historic high of over 19,000 was reached in 2006 but has been trading in the range of 5,500 to 7,500 in recent years.

Companies represented on the index include banks such as the Arab National Bank and HSBC Saudi Arabia, petrochemical companies SABIC and SAFCO, and construction companies such as Zamil Industrial and Saudi Industrial.

The MSCI TADAWUL 30 (MT30) Index represents the performance of approximately the 30 largest & most liquid securities listed in the Saudi stock market. Moreover, securities' weight will be capped at 15% Capping Threshold to minimize the dominance of large securities in the Index.

Dubai Financial Market General Index (DFM General) is a free-float market-capitalization-weighted price index comprising stocks of listed companies. The base value of the index is 1000 as of January 1, 2004.

The FTSE ADX Index Series is designed to represent the performance of companies listed on the Abu Dhabi Securities Exchange (ADX) providing investors with a comprehensive and complementary set of indexes that measure the performance of the major capital and industry segments of the Abu Dhabi stock market.

The FTSE ADX Index Series consists of the FTSE ADX General Index; 10 sector-specific indexes that include Telecommunications, Healthcare, Financials, Real Estate, Consumer Discretionary, Consumer Staples, Industrials, Utilities, Basic Materials, and Energy; and the new FTSE ADX 15 Index (FADX 15) – representing the top 15 eligible companies listed on ADX.

The EGX 30 Index is a free-float capitalization-weighted index of the 30 most highly capitalized and liquid stocks traded on the Egyptian Exchange.

The QE General Index is a major stock market index that tracks the performance of the 20 most liquid companies traded on the Qatar Exchange.

The Boursa Kuwait Main Market 50 (BK Main 50) Index is a new Market Capitalization Weighted Index (Index) that will reflect the top 50 liquid companies listed on the Kuwait Stock Exchange.

European stock indices

Some of the most popular European stock indices include the FTSE100 in the UK, the DAX in Germany, the CAC 40 in France, and the Stoxx50, which represents a range of companies across the Eurozone.

The London Stock Exchange, one of the most popular stock exchanges in the world, also has its own stock index - the FTSE100. The FTSE (or Footsie) represents 100 companies from the London Stock Exchange, including 3i, AstraZeneca, Aviva, BAE Systems, Barclays, BHP, BP, British American Tobacco, BUNZL, Diageo, EasyJet, Experian, GlaxoSmithKline, Glencore, HSBC, Just Eat, Lloyds Banking Group, Prudential, Reckitt Benckiser, Rio Tinto, Rolls-Royce Holdings, Royal Bank of Scotland, Royal Dutch Shell, Tesco, Unilever, Vodafone Group, and so on.

The DAX is an index composed of the 40 largest companies on the Frankfurt Stock Exchange, based on their market capitalization and volume order books. The German stock index is managed by Deutsche Borse and prices have been calculated every second since January 1, 2006, by the electronic system Xetra.

Given that Germany is Europe's largest economy, the DAX40 is a very popular index for international traders.

The companies represented by the DAX index include: Adidas, Allianz, BASF, Bayer, BMW, Comerzbank, Deutsche Bank, Deutsche Telekom, Fresenius, Henkel, Infineon, Linde, Lufthansa, MAN, Metro, RWE, SAP, Siemens, VW , and more.

The CAC 40 is the main stock index of the Paris marketplace and was established on June 15, 1988. The CAC 40 index is determined from the prices of the 40 companies with the largest market capitalizations listed on the Paris Stock Exchange.

Since December 1, 2003, the CAC 40 has adopted the floating market capitalization system to align with the way in which major global indices operate. This means that since that date, the number of securities available for purchase on the market for a company is taken into account in calculating the index.

Some of the companies listed on the CAC 40 index include: Accor, Air Liquide, Airbus, ArcelorMittal, AXA, BNP Paribas, Capgemini, Carrefour, Danone, L'Oréal, LafargeHolcim, LVMH, Michelin, PSA, Renault, Sanofi , Sodexo, Total, and more.

The IBEX 35 is the benchmark stock market index of Bolsa de Madrid, Spain's principal stock exchange. It is a market capitalization-weighted index comprising the 35 most liquid Spanish stocks traded in the Madrid Stock Exchange General Index and is reviewed twice annually.

Among the top components are Santander Bank, Banco Bilbao Vizcaya Argentaria (BBVA), International Airlines Group (IAG), Caixabank, Telefonica, Inditex or Repsol.

Finally, if you're interested in trading the Eurozone economy as a whole, there is an index you can use!

Euronext is the main stock exchange in the European area, and the Euronext stock index (the Euro Stoxx 50 index), includes 50 companies from the European area, based on their market capitalization.

Other European indices

While we've listed the most popular European stock indices above, there are a number of other European stock indexes. Here is a shortlist of them:

  • Belgian stock index: The BEL20
  • Greek stock index: Athex20 index
  • The Danish stock index is OMX Copenhagen 20 (or KFX)
  • Dutch stock index: AEX25
  • Finnish stock index: OMX Helsinki 25 (OMXH25)
  • Irish stock index: ISEQ
  • Italian stock index: FTSE MIB
  • Luxembourg stock index: Luxx
  • Norwegian stock index: OBX25
  • Portuguese stock index: PSI 20
  • Spanish stock index: Ibex35
  • Swedish stock index: OMX Stockholm 30 (OMXS30)
  • Swiss stock index: SMI20

The Bottom Line

Index Investing can only be done indirectly, but CFD trading offers an accessible way of investing in the price movement of a whole market sector, without actually owning the underlying index constituents.

Index ETFs are very liquid, cheap to own, and may come with zero commissions. They are the perfect set-it-and-forget-it index option.

Indexing on your own requires time and effort for researching and building the proper portfolio and can be costly to implement.

Find out more about a range of markets with CAPEX Academy’s online courses and test yourself with a risk-free demo account.

FAQs:

How are Stock Indices calculated?

The first indices were calculated as simple averages. The share prices of all the constituents were totaled and divided by the number of companies. But some major indices today, like the NASDAQ–100 and Hang Seng, are weighted averages. The two major formulas used to calculate the value of a weighted index are value-weighted and price-weighted.

Market-value-weighted indices

Market-weighted indices are calculated on the total market cap of their constituent companies. This means that the largest companies have the most impact on the index’s value.

The market cap of each company is calculated based on free-float shares publicly available for trading. A company’s free float market cap is lower than its total market cap, as it excludes shares held by company insiders.

The FTSE 100 and DAX 30 are examples of market-value-weighted indices.

Price-weighted indices

Price-weighted indices are calculated on the share price of their constituent stocks. This means that companies with the highest share prices have a stronger impact on the value of the index.

Price-weighted indices are less common than those based on market cap. The Dow Jones Industrial Average is the best-known example of a price-weighted index.

Is index investment recommended?

Index funds, at their best, offer a low-cost way for investors to track popular stock and bond market indexes. In many cases, index funds outperform the majority of actively managed mutual funds. One might think index investing is a no-brainer, a slam-dunk.

How much does an index investment yield?

Attractive returns – Like all stocks, the S&P 500 will fluctuate. But over time the index has returned about 10 percent annually. That doesn't mean index funds make money every year, but over long periods of time, that's been the average return.

Index investment is not profitable?

There are few certainties in the financial world, but there is almost zero chance that any index fund could ever lose all of its value.

What are the top 5 stock market indices to invest in?

There are 3.05 million stock market indices around the world, according to the Index Industry Association. They range from large company indices to industry sub-sectors, such as consumer staples, and themes, like environmental, social, and governance (ESG).

The top five indices by volume are the NASDAQ–100, S&P 500, Hang Seng, FTSE 100, and DIJA.

What is the most popular stock market index?

The stock market index with the highest average trading volume is the NASDAQ–100. The Invesco QQQ ETF (QQQ), which tracks the index, has become one of the world’s largest ETFs.

Between 2009 and 2019, the NASDAQ-100 gained 372%, based on price, with a total return of 430%, including dividends. However, as always, it’s crucial to remember that past performance is no guarantee of future returns.

How are indices compiled?

Indices are managed by committees, which set the criteria that company stocks must meet to be eligible for inclusion.

These committees meet regularly to review the index rules and make decisions about whether to add or remove companies. Some committees hold reviews quarterly while others opt for annual reviews.

Some committees remove stocks that no longer meet the eligibility criteria, while others allow them to remain, or give them time to return to compliance.

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You should independently evaluate each financial product and consider the suitability of such a financial product, by taking into account your specific investment objectives, financial situation or particular needs, and by consulting an independent financial adviser as needed, before dealing in any financial products mentioned in this document.

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