Relevant Market Sectors Research
Before you start trading an index, it is important to examine the component parts of that index; does it compose of shares from various industries, or are most of its shares from a particular market sector? Answering these questions could be crucial to your understanding of ways that could influence the value of the index.
For example, FTSE 100 index listed companies are those that have the highest UK market capitalization representing an approximate 80% of wealth at the London Stock Exchange. This is why the FTSE 100 can be said to provide a good insight of UK companies market activity. In addition, more than 10% of all shares listed here are energy and mining stocks. Price changes of commodities that are related to these sectors could cause commodity-related stocks falling or rising, and so may significantly affect the index value.
When you are deciding on an index to trade, it is important to consider the number of listings making an equity index. – Number of listed companies on an index can vary widely; some will contain thousands, whilst others could contain only a few tens.
Study Relationships between Indices and Currencies
Another important thing is to understand the sensitivity of an index to currency rates. It’s typical to have a correlation between the strength of a currency and its domestic indices value.
For instance, if there is a US Dollars demand, American indices will generally increase in value. This could be partly because of foreign investment – as the number of traders investing in US stocks grows, they would need to first buy USDs to be able to purchase American stocks, which in turn causes value increase to the US indices.
Look for Correlations between a Country’s Domestic Index and Commodities
As commodity prices decrease or increase, the relative value of some currencies could be susceptible to change. For example, if the prices of oil drop, maybe, as a result of a weak global demand, then a country like Canada, which is an oil exporter, would have an economic disadvantage, but Japan, which imports oil, would benefit.
For this reason, it’s crucial to study commodity movements which may potentially affect value of an index you may be trading. Correlations could fluctuate from one day to the other, but in the long term, you can expect strong trends. Analyzing and searching patterns can help you make good trading decisions.
Changes to Index Listings
Over time, stocks that are listed on an index are typically subject to change as a result of factors such as mergers and acquisitions as well as market capitalization. These factors are described some more below.
Market capitalization:
Most indices will value companies in terms of market capitalization and not in total assets or sales figures. The total market value of a business’s issued shares is its market capitalization. This calculation is done by multiplying the current market price of a share by the number of shares issued.
Because an index’s total market capitalization is affected by the company’s individual share prices, the index’s value will change as prices fluctuate. For instance, as indicated above, the FTSE100 index on average represents share prices of London Stock Exchange’s top 100 publicly traded companies. To make sure it reflects these 100 top companies, the FTSE is revised on a quarterly schedule, in March, then June, September and then in December. This makes an index’s component stocks to change over time.
As an example, if one company’s market capitalization plummets, the company stocks could become too small for them to remain on an index they are listed on. This causes the company to be demoted from the index, and another company that has a higher market capitalization replaces it.
Mergers:
When mergers occur, there can be change on stocks listed on an index. When two companies combine to form one business, their various stocks also combine forming one tradable entity. One example of this is the merger of Dixons and Carphone in 2014.These previously separate stocks joined into Dixon Carphone.