Interested in learning some valuable stock trading education that can help you take your investing to the next level? One key piece of information that can facilitate your efforts in this area is indices, as learning more about these measures can provide several benefits.
An index is simply a method that has been designed to measure the price movements of a market for a certain asset or a particular aspect of that market, according to an All About Indices, an article provided 360 Degrees of Financial Literacy. Indices are developed by companies using specific characteristics for assets they want to include, for example the size of a company with the stock that is being considered or where the firm is headquartered.
Once the index is created, the firm will calculate the value of the entire measure by quantifying the different parts and then adding them up, the media outlet reports. There is a measure of this type for practically asset class in existence, but the stock market in particular has many different ones.
Dow Jones Industrial Average
One of the best-known indices is the Dow Jones Industrial Average, which contains the stocks of 30 of the largest "industrial" companies, according to the U.S. Securities and Exchange Commission Office of Investor Education and Advocacy. The Dow contains equities representing firms in various industries, such as retail, financial services and information technology.
One of the most frequently-cited examples of one of these indices is the S&P 500 Index, which is used as a benchmark by many market experts, according to All About Indices. The group of stocks is considered by many to be a broader measure of the equity markets since it is derived from the prices of securities in 500 different companies. In comparison, the Dow only uses 30.
The S&P is frequently used as a benchmark for the performance of other securities. It can be harnessed to analyze the returns of the stocks of larger U.S.-based firms. Many investment schemes - such as mutual funds and other financial instruments that are actively managed - are often compared against the S&P 500 to evaluate performance.
Russell 2000 Index
While the S&P 500 and the Dow can be used to measure the performance of larger stocks, the Russell 2000 serves a different purpose in that its value provides a quick snapshot of how well smaller firms are doing, according to the U.S. Securities and Exchange Commission Office of Investor Education and Advocacy. The Russell 2000 Index provides a figure to represent the performance of the 2000 smallest publicly-traded companies based in the U.S.
Investing using equities
At this point you may be wondering what information you can use from this to generate returns through investment. All About Index notes that you cannot directly in an index, since it is not a financial instrument. However, there are many securities that are designed to track the price movements of indices.
For example, you have the ability to trade exchange-traded funds that can grant you quick exposure to the S&P 500 Index or other key indices. There are other securities that you can use to obtain this same objective, for example index funds.
It is important to note that there are certain factors that could prevent a financial instrument from replicating the exact price movements of an index, according to the media outlet. This incidence is called tracking error. Also, there are costs associated with the securities that attempt to mimic these groups of stocks, such as taxes and operating expenses.
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