Introduction to Equity Indices

What is an Equity Index, and what are some examples?

An index whose value is derived from a weighted average or aggregate of a group of stock prices of different companies that represent either a particular country or a sector of the company.

Example include:

• US - S&P 500 and NASDAQ 100
• UK - FTSE 100
• Germany - DAX 300
• Japan - NIKKEI 225

There are also global indices such as the MSCI World Index, which is made up from a selection of stocks from all over the world.

What are the two main types of Equity Index?

1. Price-weighted index - The Dow Jones Industrial Average, or DJIA, is a price-weighted index that was first released in 1896 and comprised the 12 largest stocks in the United States
2. Market-value weighted index - The S&P 500 is a market value weighted index that represents the market capitalisation of the top 500 US companies and has been published since 1957. This index provides a much clearer representation of the overall output of the market

Why do people trade indices?

Trading in individual companies can be challenging and dangerous for unskilled stock pickers. Trading indices allows you to have a macro view and not be exposed to stock-specific risk. Monitoring index moves every day gives you a sense of what the overall market is doing without being overly worried with individual stocks. Typically, when the economy is doing well, the large market indexes begin to grow. In periods of recession or crisis, indexes begin to fall. Sector indices are also very popular as they allow investors to get exposure to sector trends or themes, again without having to determine who the individual winners and losers will be.

What are ETFs, futures & options?

• Exchange Traded Funds - A fund whose price is determined by a basket of securities that it is trying to track or replicate. It contains all types of investments including stocks, commodities or bonds
• Futures - Exchange-traded contracts that allow investors to take a long or short view on an index. Often used as a hedging instrument by traders to hedge the overall broad market exposure
• Options - Non-linear in nature and are also used for macro hedging, especially on indices