In addition to individual stocks, you can also trade an asset called an index on the stock market.
A stock market index is a group of stocks combined according to certain criteria. It reflects the weighted average price of the companies included in it and serves as a barometer for the overall market or a specific sector of the economy.
Examples:
S\&P 500 — a US index that includes shares of 500 of the largest companies.
NASDAQ — an index of companies specializing in technology and biotechnology.
Types of indexes
There are many indexes, each calculated using its own formula. The two most common types are:
Market capitalization-weighted indexes
The larger the company’s market capitalization, the greater its impact on the index.
Example: FTSE 100 (UK).
Price-weighted indexes
The more expensive the share, the greater its weight in the index.
Example: Dow Jones Industrial Average (US).
Regional indexes
Indexes often reflect the state of a country’s or region’s economy:
FTSE 100 — United Kingdom (often called the “barometer of the British economy”).
CAC 40 — France.
DAX 30 — Germany.
Example:
If the FTSE 100 drops, it may signal problems in the British economy.
Indexes as indicators of market sentiment
Indexes help understand what’s happening in the market:
If they rise, investors are optimistic and willing to take risks.
If they fall, caution or panic dominates.
However, market sentiment doesn’t always reflect the real economy. Sometimes declines are caused by temporary negative news rather than fundamental company problems.
Sector indexes
There are indexes reflecting the state of specific industries:
- Banking indexes (e.g., Keefe Banking Index).
- Mining indexes (e.g., FTSE 350 Mining).
- Echnology, pharmaceutical, construction, and others.
Why is this useful?
Helps analyze the prospects of specific sectors.
Allows trading by sectors (buying promising ones and selling vulnerable ones).
Example:
During a crisis, you can sell construction indexes (cyclical sectors) and buy pharmaceutical ones (defensive sectors).
During economic growth — do the opposite.
Why trade indexes?
Diversification: You invest in a group of companies instead of just one.
Economic reflection: An index helps understand the state of a country or sector.
Flexibility: You can open both long (buy) and short (sell) positions.
Conclusion
Indexes are a convenient tool for analysis and trading. They help you understand overall market sentiment, assess the state of the economy, and explore the prospects of specific sectors.