The US stock indices are a major part of the investing community because they offer many opportunities to make big bucks.

To become a successful trader, there are many things that you need to consider and pay attention to. One of the essentials that could help you analyze the market situation better is called the stock index or indices. Beginners might have heard about them in the news, but don't exactly understand what they are and how they work. However, for experienced traders, stock indices are crucial to monitor, especially the US, European, and Asian indices.

US indices

A stock index basically refers to a group of company stocks across many different industries. The collected data forms a big picture that could help investors calculate the market's performance by comparing the current prices with the past prices. Each index typically focuses on a specific area of the market. For instance, the Nasdaq stock index gathers insights from the technology sector. So if you want to see how technologies companies are currently doing, you can pay closer attention to the Nasdaq index. Indexes also vary in size as some of them only track several stocks, while others track thousands.

As the largest economy in the world, it is expected that the performance of the US stock market is important to stock trading as a whole. This is why US indices are always a hot topic among stock traders. Here's everything you need to know about it.

 

Trading with US Indices

Stock indexes are popular because they provide information for a number of different stocks, not just one. This makes them an excellent analysis tool.

It is important to understand that US indices cannot be traded directly. When you hear that someone is going short on NASDAQ 100 or long on S&P 500, they are not actually trading with the actual indexes. Instead, they are trading on a futures or options market, such as the NQ futures market or the SPXW options market. The value of each futures or options is derived from the movements of the index it tracks. Hence they are also known as derivatives.

Like regular derivatives trading, you can also trade US indices with leveraged products like CFDs or spread trades. This allows you to amplify your position size and get the chance to earn more profit. However, remember that the profits and losses are all based on the trade's total value, so these products are highly risky.

 

The Advantages

As mentioned, stock indices are a great analysis tool. Instead of tracking the performance of each individual stock, you can just track an index and collect all of the information you need. But other than that, there are several more benefits that you can get from trading indices, such as:

 

Provides Good Diversification

Trading with indices is one method to reduce the risk in asset trading because it allows you to diversify your trades. Remember that every single index consists of several to thousands of stocks from different companies and industries. Therefore, by trading with indexes, you're not putting all your eggs in one basket.

If you trade with an individual stock, one huge price swing can cost you a lot because you're fully relying on the asset. But if you trade with an index and one of the companies that it tracks is having a downturn, you won't get as much impact on your trades. This makes indices relatively safer and has lower risks as well as costs compared to individual stocks. On top of that, trading with indices allows you to diversify with only one position, which is less complex as opposed to managing several positions at once.

 

Easy Access for Beginners

US indices offer easy access to the US stock market. While it is more suitable for experienced traders, trading with indices can be a great starting point for beginners as well because it is full of essential data that can be turned into trading insights. In addition, there are loads of learning resources available on the internet these days that could teach you about US indices and how they can help you gain bigger profits.

 

Hard to Manipulate

Lastly, it's hard to manipulate the prices of stock indices because they can't be directly bought or sold. Because the value of each index depends on the price of all of its stocks, a huge shift in price from a particular stock won't impact the overall performance of the index.

 

The Downsides

On the other side of the spectrum, we also need to acknowledge that US indices are not free of risks. Here are some of the downsides that you might find in trading with US indices:

 

Volatility Concerns

We've mentioned that US indices can reduce trading risks as the price is relatively more stable compared to individual stocks. However, that is not to say that volatility doesn't matter at all. You still need to check the performance of the stocks that the index tracks because its value might be greatly influenced by companies, especially the large ones with significant weighting.

 

Some are Less Liquid than Others

Not all indexes have the same liquidity level. If the liquidity is low, then it typically takes longer to execute an order and it often leads to negative slippages.

 

Less Liquid Indices Mean Higher Fees

If you trade with indexes that have low liquidity, you'll more likely to get higher trading fees. Sometimes, they also have higher margin requirements, which means you'll need more money deposited in your account to open a position.

 

Types of Weighted Indices

Each stock in an index has a certain weighting assigned to it. Stocks with higher weightings have a bigger impact on the index's price value than others with lower weightings. In this case, there are several ways to separate indexes based on how the weightings are assigned to the stocks:

 

Price-weighted Indices

This index type relies on the price of the stock to determine the weighting. Therefore, the higher the share price, the more influence that the stock can give to the index. Note that this doesn't necessarily always point out to giant companies because sometimes, companies with smaller capitalizations actually have the higher prices. The Dow Jones Industrials is an easy example of an index that uses the price-weighted method.

 

Market-weighted Indices

Meanwhile, this index type relies on the market capitalization of individual stocks. The biggest company in the index based on market capitalization should have the biggest influence on the index's price value. This means giant companies like Apple and Microsoft must have greater impacts on an index compared to other smaller companies. The S&P 500 is an example of it.

 

3 Most Popular US Indices

The following are the most-watched and talked about US indices in the financial market:

 

Dow Jones Industrial Average (DJI)

Dow Jones Industrial Average (DJIA) or The Dow 30 is a popular index that consists of the top 30 blue-chip US companies. Some of these companies are Apple, Nike, Walmart, Intel, McDonald's, Coca-Cola, and more. Dow 30 is actually a part of the S&P Dow Jones Indices and covers almost all sectors of the economy except for transportation and utilities because they are represented by the Dow Jones Transportation Average Index and the Dow Jones Utility Average Index respectively. Together, all three of them make up the Dow Jones Composite Average Index.

It's also worth mentioning that since the Dow 30 is made out of prestigious companies only, it doesn't necessarily reflect the overall US stock market. So, if the Dow falls, it doesn't mean that the whole market has fallen too.

 

S&P 500

S&P 500 is one of the oldest indexes in the world and the first-ever index to use the market-weighted method back in 1957. This index is made up of the top 500 companies in the US across about 11 sectors and represents about 80% of the US stock market's total value. Some of the top sectors in the S&P 500 are information technology, health care, and communication service.

 

Nasdaq Composite Index

The Nasdaq Composite Index comprises of roughly 3,000 companies that are part of the Nasdaq stock exchange across various sectors, but primarily focuses on technology stocks. Meanwhile, the Nasdaq 100 is a narrower index that focuses on the biggest 100 non-financial companies based on market capitalization. Both are excellent choices for those who want to focus on large-cap stocks and their performances.

 

The Bottom Line

The US stock market is definitely a huge attraction to any trader as it is home to some of the top blue-chip firms in a rather safe and stable financial environment. Hence, there is a bagful of opportunities for individual traders to generate significant profit from their trades. For traders to get exposure to the market and invest in various US companies like Microsoft, Apple, and Google, the US market has many indices to choose from.

Tell us what you want to find

Trading with US indices can also be a great start for any trader worldwide as it has many advantages such as lower cost, lower risk, and diversification. The most important thing is to learn about each index that you're planning to focus on. Once you do that, you can start choosing brokers that provide CFDs for stocks and indices.