Index trading is a popular activity in Australia, and many people prefer to trade indices over stocks due to their generally lower risk, higher stability, and easy gateway to portfolio diversification. If you are looking to get into index trading this year, it is vital that you understand what indices are, why people trade them, and the most popular Australian indices around.
In this article, we strive to break down the basics of indices and index trading. We will also provide examples of some of the biggest Australian indices and the companies they track. If you are keen to learn about this, read on.
What are indices?
Indices, or stock market indices, are benchmarks of the stock market. They track the overall performance of a group of stocks of a specific market, sector, or region, and investors can use indices to compare the performance of their portfolios to the market as a whole with indices.
Some of the most well-known indices are the S&P 500 in the United States, the FTSE 100 in the United Kingdom, and the Nikkei 225 in Japan. These indices track the performance of the largest stocks from various industries in these respective countries, and the value of the index depends on the collective performance of these stocks. This is an example of stock indices based on market.
Generally, the number behind the index name is the number of companies the index is tracking. For example, the S&P 500 in the United States tracks the 500 largest companies by market capitalisation in the US.
Indices can also measure the performance of a specific type of stocks in specific sectors or those with shared characteristics. For example, technology stocks, energy stocks, or financial stocks, or stocks from emerging countries. This is particularly useful for investors interested in the development of a certain sector or country, and they can use these indices to compare the performance of their investments to those markets.
Why do people trade indices?
People trade indices for a variety of reasons, but mostly because it offers broad exposure to a variety of stocks and carries lower risk than if they were to trade stocks online. Below, we take a look at some of the main reasons why index trading is popular amongst investing Australians.
Easy gateway to diversification
Trading indices is a quick and easy way for investors to speculate on a broad basket of stocks with shared characteristics or on the overall market performance in Australia. Instead of having multiple positions open tracking the largest blue-chip companies in the country, investors can simply invest in an index with one open position.
When traders spread their risk across a large number of stocks, they reduce the impact of a single stock’s performance on their portfolio. This reduces the overall risk of their investment, as when one stock performs poorly, there is little impact on the overall performance of the index, especially if the index tracks over a hundred companies.
Lower cost of investing
Trades only need to open and maintain one position to gain exposure to a large number of companies. This means they reduce the cost of trading – from transaction fees to overnight charges. The fees for trading indices are also typically lower than those for trading individual stocks.
As indices comprise many companies, they are generally more liquid than stocks. Of course, it does depend on the individual stock you want to invest in. Blue-chip stocks will remain more liquid than most instruments in general. However, if you have your mind set on smaller companies, investing in an index that focuses on a basket of small companies instead of the single stock will for sure be easier when it comes to entering and exiting positions in the market.
Traders interested in a particular segment of the stock market will find it easy to narrow down their interests and invest accordingly with indices. This is because indices track the performance of stocks with shared characteristics. This means that if someone is interested in how the technology sector is developing, they can simply invest in the appropriate index that tracks the performance of the technology sector.
Access to the big picture
Finally, index can provide useful insights into the overall trend of the Australian stock market and beyond. This makes it easy for traders to make informed investment decisions.
Indices in Australia
In Australia, there are several stock market indices that track the performance of its securities market. Some of the most famous indices include:
The S&P/ASX 200 is the most well-known index in Australia. It tracks the 200 largest and most liquid companies listed on the Australian Securities Exchange (ASX), and many investors view this index as the benchmark for the overall performance of the Australian stock market. Some examples of companies this index tracks include the Commonwealth Bank of Australia, the BHP Group, CSL, Westpac Banking, and the Australia and New Zealand Banking Group.
The S&P/ASX 50 index tracks the performance of the 50 largest and most liquid companies in Australia. Naturally, all the companies this index tracks are also present in the list of companies the S&P/ASX 200 tracks. Some blue-chip companies outside of the ones listed previously include the Australian Foundation Investment Company, the Goodman Group, Origin Energy, and Telstra.
S&P/ASX Small Ordinaries
The S&P/ASX Small Ordinaries index is a market-capitalisation-weighted index. It tracks the performance of all companies listed on the ASX, except for the ones included in the S&P/ASX 200. This is a great index that provides a broader perspective on the performance of smaller-cap stocks in Australia. Some examples of companies this index tracks include Technology One Limited, NIB Holdings Limited, Seven Group Holdings Limited, and Chorus Limited.
MSCI Australia Index
The MSCI Australia Index stands for the Morgan Stanley Capital International Australia Index. This index tracks the performance of the largest and most liquid companies listed on the ASX. It strives to give investors an accurate overview of the performance of the Australian market, and companies included in this index include the BHP Group, the National Australia Bank, Westpac Banking, and the Commonwealth Bank of Australia.
Can I trade indices from other countries?
Just because you are located in Australia does not mean you are limited to trading indices in the Australian stock market. In fact, you can gain access to international stock markets when you choose an international broker that offers access to them. This means you can participate in trading the FTSE 100 in London, the DAX 30 in Germany, and other indices, depending on your investment preferences. Before opening an account with a broker, check the instruments and markets they offer.
The bottom line
Trading indices can be a great way for traders to diversify their portfolios. It is also a generally lower-risk investment, and it has the potential for high returns just as individual stock trading does. Nevertheless, before trading, it is important for traders to know that index trading carries a level of risk, and they should never expect returns in every investment they make. It is always advisable for traders to do their independent research on various markets, indices, and brokers before opening any accounts and positions.