Stock market indices are a very important feature of our daily financial news and it is important that the mechanics behind them are fully understood before you consider using the information from them for investment purposes. With a wealth of historical and current information on the major indices available online, just about anyone can begin confidently trading indices with opportunities for serious profits. Here are five steps to help you get started.
- Start with the basic definitions.
An index is a measurement of the changes in a pool of stocks which represent a segment of the market. They tell us where the market is going and what the likely trend is. Investing in an index is a much easier and cheaper option than investing in every stock in the index itself. It would be very tedious to follow every single stock traded in a market so a small segment of the market is chosen that is as much as possible representative of the total market.
- Understand what makes an index rise and fall.
Any change in the price of an index mirrors an exact comparative change to the stocks which are in the index. As we have seen, stocks are components of the overall index so any movements either up or down in the value of the stock will likely change the price of the overall index. It follows therefore that a change in a stock price in an index with fewer components such as the DAX 30 will have a greater knock-on effect on the overall index value compared to that of a larger index like the S&P 500.
- Look for macro trends.
Once you start following the markets, you will note that there are market trends that can be observed broadly in certain sectors of the stock market. Comprehending these market trends and knowing how to evaluate stock prices is vital. Stock Index trading values spanning the whole day are continuously recorded and an average is taken at the end of each day. A comparison of these averages will give you a good idea as to the price movements of the stocks.
- Learn more about the world’s most popular indices.
In the US there are three major indices: The Dow Jones Industrial Average, one of the most widely quoted of all the market indicators which consists of 30 of the largest publicly traded firms in the U.S., the Standard and Poor’s 500 (S&P 500) containing the stocks of 500 Large-Cap corporations which comprises over 70% of the total market cap of all stocks traded in the U.S. and the NASDAQ Composite, a broad market index of all of the common stocks and similar securities traded on the NASDAQ stock market. Other major indices are the Nikkei 225, the stock market index for the Tokyo Stock Exchange, the UK FTSE 100 which contains 100 of the most highly capitalised companies traded on the London Stock Exchange and the DAX 30 which measures the performance of the 30 largest German companies.
- Monitor more than one index.
One final point to remember is that following one index is not sufficient as it will not give the true picture of prevailing market status. It is recommended that you take into account all the major indices across all asset classes before making a decision about investing.
Remember that not all news will have an impact on the price of the stock and subsequently the index. What’s important is how the trading community reacts to the news which is largely based on perceived impact. Understanding what influences prices can help you to determine the correct price direction when you are placing your trades.