The face of equity markets have continued to change through the years with the focus more on a broader index rather than the individual stocks. An index is generally a specific grouping of stocks such as the S&P 500 index in the US or the DAX in Germany or the Nikkei in Japan. Equity index trading reflects the aggregate health of the equity markets in individual countries and allows investors to initiate a broad macro play on a country’s stock market.
An equity markets is a public enterprise for the trading of company shares at a decided price on an agreed exchange. The shares are listed and exchanged in a marketplace where companies that specialize in the business of trading and clearing list the shares. The biggest equity market in the United States, by capital, is the New York Stock Exchange (NYSE).
Market members include individuals, institutional traders, banks, insurance company’s mutual funds, hedge funds, and also public companies trading their own shares. Liquidity in large capitalization stocks, are generally more liquid that stocks with small capitalization. Stocks are considered one of the major asset classes in which individuals and institutions allocate capital. Trading the equity market requires an understanding of the types of securities available, the valuation process, and capital flows.
When investors refer to equities they are generally discussing common stocks. Common stock is a form of security in which the owner of the security holds equity in a corporation. Common stocks can have voting or non-voting shares. Common shares are the bottom of the capital structure and are usually last to receive a return of capital in the case of a bankruptcy. In the event of liquidation, common share holds receive recourse behind bondholders, lenders, and preferred share holds. As the most risky shares in the capital structure common shares generally generate the best capital appreciation.
Common Stock usually provides traders the right to vote on certain issues, such as selecting administrators. Those who own common shares are able to affect the company through ballots on creating business objectives and policy, as well as electing a board of directors.
An equity index is generally composed of liquid common stocks. In the US the three largest indices are the S&P 500, the Dow Industrial Average and the Nasdaq composite. While the S&P 500 reflects a wide spectrum of companies, the Nasdaq is highly leveraged to the technology space.
By trading indices, and investors can achieve exposure to a country’s equity market. Investors can also short indices betting that these markets will move lower. Investors can also take on pair trades, where they purchase one indices and simultaneously short another. For example, if an investors is bullish Germany relative to the United States, they could purchase the DAX and simultaneously short the S&P 500 index.
Index trading provides exposure to common stocks without the headache or purchasing individual shares through a stock broker. Given that the majority of the stocks in an index trade in tandem with the index, trading indices is the most practical way to achieve exposure to a country’s stock market.
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