Stock markets world wide maintain a various “Indices” with the stocks that comprise each market. Each Index represents a selected industry segment, and the broad market itself. In many cases, these indices are tradable instruments themselves, which feature is called “Index Trading”. An Index represents an aggregate picture in the companies (generally known as “components” from the Index) that comprise the Index.
For example, the S&P 500 Index is usually a broad market Index within the United States. The components in this Index are definitely the 500 largest companies from the U.S. by Market Capitalization (also known as “Large Cap”). The S&P 500 Index can also be a tradable instrument within the Futures & Options markets, also it trades within the symbols SPX inside Options market, and in the symbol /ES within the Futures markets. Institutional investors in addition to individual investors and traders manage to trade the SPX along with the /ES. The SPX is simply tradable during regular market trading hours, even so the /ES is tradable almost 24 hours a day from the Futures markets.
There are a couple of reasons why Index trading can be quite popular. Since the SPX and the /ES represents a microcosm on the entire S&P 500 index of companies, a venture capital company instantly gets contact the entire basket of stocks that represent the Index after they buy 1 Option or Future contract with the SPX plus the /ES contracts respectively. This means instant diversification on the largest companies inside U.S. that are part of the convenience of merely one security. Investors constantly seek portfolio diversification to protect yourself from the volatility related to holding just a couple of company stocks. Buying an Index contract offers an easy way to do this diversification.
The second reason for your popularity of Index trading is due towards the way the Index is itself designed. Every company within the Index features a certain relationship while using Index in relation to price movement. For example, we could often observe that when the Index rises or falls, a majority from the component stocks also rise or fall very similarly. Certain stocks may rise in excess of the Index and certain stocks may fall over the Index for similar moves inside the Index. This relationship from the stock and it is parent Index could be the “Beta” on the stock. By considering past price relationships from a Stock and Index, the Beta for any stock is calculated and is also available on all trading platforms. This then allows a trader to hedge a portfolio of stocks against losses by ordering or selling some number of contracts from the SPX and the /ES instruments. Trading platforms are getting to be sophisticated enough to instantly “Beta Weigh” your portfolio on the SPX and /ES. This is really a major advantage every time a broad market crash is imminent or possibly is underway already.
The third selling point of Index trading is that it allows investors to look at a “macro view” in the markets within their trading and investment approaches. They don’t have to worry about how individual companies from the S&P 500 Index perform. Even if an incredibly large company were to face adversity inside their businesses, the impact the corporation would have about the broad market Index is dampened by the fact that other businesses could be achieving a lot. This is just the effect that diversification really should produce. Investors can tailor their approaches dependant on broad market factors in lieu of individual company nuances, which could become very cumbersome to adhere to.