Stock markets around the world maintain different “indices” for the stocks that make up each market. Each Index represents a specific industry segment or market as a whole. In many cases, these indices are tools that can be traded, and this feature is called “Index Trading.” The index is an aggregate view of the companies that make up the Index (also known as the “components” of the Index).
For example, the S&P 500 Index is the largest market index in the United States. The components of this Index are the 500 largest companies by market capitalization in the United States (also known as the Big Cover). The S&P 500 Index is also a tool that can be traded in the Futures & Options market and trades under the SPX symbols in the Options market and under the Futures / ES symbol. Along with enterprise investors, individual investors and traders also have the ability to trade with SPX and / ES. SPX is only traded during normal market trading hours, but / ES Futures markets are sold almost 24 hours a day.
There are several reasons why index trading is so popular. Since SPX or / ES represents a single microcosm of all S&P 500 companies, an investor is immediately exposed to a basket of all shares representing the Index when it purchases SPX 1 Option or Future Contract and / ES contracts. respectively. This means instantaneous diversification designed for the convenience of one security for the largest companies in the United States. Investors are constantly trying to diversify their portfolios to avoid volatility in the shares of only a few companies. Getting an index contract offers an easy way to achieve this diversity.
The second reason for the popularity of index trading is due to the design style of the index itself. Each company in the index has a certain relationship with the Index when it comes to price movements. For example, as the index rises or falls, we can often see that most of the component stocks rise or fall in a very similar way. For similar actions in the index, certain stocks may fall more than the Index and certain stocks may fall more than the Index. This relationship between a stock certificate and its parent index is the “Beta” of the stock. Looking at the past price relationship between a Fund and the Index, Beta is calculated for each share and is available on all trading platforms. This then allows an investor to protect a portfolio against losses by buying or selling a certain number of contracts on SPX or / ES instruments. Trading platforms have become sophisticated enough to “pull” your portfolio into SPX and / ES immediately. This is a big advantage when a large market collapse is approaching or has already begun.
The third advantage of index trading is that it allows investors to have a “macro view” of the markets in their trading and investment approaches. Individual companies in the S&P 500 Index will no longer have to worry about how they perform. Even if a very large company faces difficulties in its operations, its impact on the company’s broad market index is diminished by the ability of other companies to perform well. This is exactly the effect of diversification. Investors can adapt their approaches based on broad market factors rather than individual nuances of the company, which can be very difficult to follow.
The downside of index trading is that earnings from broad markets are generally averages (average 6-8%) to medium to high figures, and investors can earn higher returns from individual stocks if they want to face them. the volatility that goes along with owning individual stocks.