Indices

What are Indices?

Indices are one of the most important indicators of the exchange market. They were established to understand how the market behaves at a given moment in time in general. The first stock index was formed in the United States at the end of the 19th century - The Dow Jones Transportation Average. It was named by Charles Dow, who proposed this indicator to measure the stock status of eleven transportation companies on the stock exchange. Later, indices became a separate financial product and the stock index contract became a standard instrument traded on the stock exchange. Globally, there is a huge variety of stock indices covering all sorts of securities, including bonds and shares. In total, there are more than 3.3 million stock indices in the world. These are not just sector indices or those of a particular stock exchange, but also the global indices that cover securities of various countries.

Pricing

Most of the existing indices are measured by the capitalization of companies, and only the oldest indices such as the American Dow Jones Industrial Average with 30 companies or the Japanese Nikkei 225 with 225 companies are based on the average price. The most widely used index in the world is the S&P 500 broad market index, which comprises the stocks of the 505 largest-capitalized U.S. companies. The combined capitalization of S&P 500 companies reached $40.36 trillion at the end of 2021. Other indices traded on the stock market include the dollar index (DXY) or other reserve currencies, which are the baskets of national currencies of the largest trading partner countries. A certain disadvantage of the existing methodology of calculating indices is considered to be the high influence of the largest companies by capitalization, such as Apple or Amazon.

CFD on Indices

An index is an ideal instrument not only for comparing the profitability of investment portfolios but also as a hedging tool, i.e. for protecting an investment portfolio in case of a sharp fall in the price of a stock it contains. There are other interrelations of indices, for example with exchange rates that reflect movements of capitals between different markets. Nevertheless, purchasing a contract on an exchange for the index is rather expensive and can cost thousands of dollars. Therefore, the CFD of the index is a more comfortable alternative. Of course, with CFDs one may open not only long positions but also short positions on indices at once.

The risks

Investing in indices is a diversification of investments, because the index is backed by numerous constituent securities. Therefore, index transactions are considered to be less risky. In this sense, the more global the index, the less volatile it is. Conversely, the narrower the base of the index, the more susceptible it is to sudden price changes. Another characteristic feature is the desire of large market participants to reach a certain value in the price of the index by the options' expiration date. After this date, the market may experience a correction, which also poses a certain risk for the investor. Nevertheless, in the long run, stock indices in developed countries show positive dynamics on average.