Trading the index instead of stocks

The S&P 500, or Standard & Poor's 500, is the world's most well-known stock index. It has a history dating back to the beginning of the 20th century but took its current form in 1957. The index consists of the 500 largest listed companies in the United States. It is market-weighted and free-float adjusted. At the time of writing, the top 10 stocks make up 27% of the index. The largest is Apple with 7.1%, followed by Microsoft 6.2%, Alphabet (Google) 3.4%, Amazon 2.7% and Nvidia at 2%. Of companies outside the technology sector, Warren Buffet's Berkshire Hathaway is the largest with 1.6%, followed by oil giant Exxon at 1.3%.

Over the past 30 trading days, the average daily volatility (ATR%) in the S&P 500 index has been 1.46%.

This index consists of the 100 largest non-financial companies listed on the NASDAQ stock exchange in the USA and was started in January 1985. The index is narrower than the S&P and has a significantly larger weighting of tech-related shares. At the time of writing, the 10 largest companies account for as much as 55% of the index value with Microsoft 12.6%, Apple 12.3%, Alphabet (Google) 6.8%, Amazon 6.2%, Nvidia 5.2%, Tesla 3 .7% and Meta (Facebook) 3.6%. The largest non-tech company is Pepsi with 1.9%.

As we can see, there is a considerable overlap between the S&P 500 and the NASDAQ 100 when it comes to the top 10 stocks, but all are more heavily weighted in the NASDAQ 100. This also results in greater fluctuations, and over the past 30 days the average daily movement (ATR%) of NASDAQ has been 1 .85%.

This index took its current form in 1896 after having existed in a slightly different variant since 1885. The founder was Charles Dow, who was then also the editor of the still famous newspaper The Wall Street Journal. The index consists of thirty stocks, and the content is selected by a committee. Originally it consisted only of industrial companies, but this has been changed in recent years so that the index better represents the wider market. In contrast to the two previously mentioned indices, the Dow is price-weighted, which means that the stocks with the highest price carry the most weight, regardless of market value. At the time of writing, the 10 largest shares account for 55% of the market value. The largest is United Health with 9.3%, Goldman Sachs 6.5%, Microsoft 5.7%, McDonald's 5.5%, Amgen 4.8%, and Caterpillar 4.5%.

As we can see, the sector spread of companies at the top of the index is greater here than on the first two, and daily fluctuations are actually smaller with the ATR last 30 days at 1.14%. This is despite the fact that the index is far narrower with only 30 companies.

Disclaimer: After many years in the brokerage industry I started my own business in 2021. I published the book "Paleo Trading: How to trade like a Hunter-Gatherer” and launched Paleo Capital that manages a hedge fund according to the principles described in the book. I emphasize that nothing written on this blog is to be regarded as personal advice or a concrete call to take positions. Everyone must be responsible for their own decisions and familiarize themselves with the products they use.

What makes the American indices special is that there is great interest from all over the world in trading them. Liquidity is thus very good during the entire period that a Nordic trader is normally awake.

A number of other indices can also be interesting to trade. For a Nordic-based trader, the German DAX index and the EU index EURO STOXX 50 will perhaps be most relevant. The first consists of the 40 largest shares on the Frankfurt Stock Exchange in Germany, while the EURO STOXX 50, as the name suggests, comprises the 50 shares with the highest market value in the Euro area. Both of these indices have very good liquidity during regular opening hours in Europe.

For our domestic Nordic indices, opportunities and product selection are more limited. This is simply connected to the fact that the markets are too small for there to be sufficient liquidity and interest from many large players in the relevant index futures. Those interested are encouraged to inform themselves.

Common to all the indices I have mentioned above is that standard futures contracts are traded on them, so-called index futures. These are the world's most traded equity-related securities, which means that they have excellent liquidity most of the day. However, trading the index futures themselves is difficult or impractical for most private customers and smaller traders, and almost none of the Nordic brokers offer electronic trading in these. However, there are good alternatives. For long-term investors, the most relevant is to look for exchange traded index funds (ETFs) which are available in the US and on some European exchanges. For short-term trading (intraday to a few days), however, product providers such as Vontobel have a wide range of products with returns linked to these indices. These products make it possible to go both long and short, and you can take positions with varying degrees of leverage.

When it comes to trading leveraged products on indices, it is important to adjust the position sizes to the risk you want to take, which I described in more detail in this previous post. Simplified, you can say that if you want an exposure of e.g. NOK 300,000 in such an index, this can be done by buying a 3X leveraged product for NOK 100,000 or a 6X leveraged product for NOK 50,000 to achieve the desired intraday exposure. Remember, however, that these are products intended for short-term trading, and it is thus very important that you familiarize yourself with how they work before taking positions. 

Trading indices instead of shares has primarily three advantages. The first is diversification and thus the spread of risk. As an index consists of a large number of shares, you will be exposed to a very small extent to what is called company-specific risk. The second and third advantages are cost efficiency and liquidity, respectively. Buying the 100 stocks in the NASDAQ 100 individually would be expensive and impractical. In contrast, taking positions in the index is cheap and easy both with larger and smaller amounts.

Trading products linked to an index are often traded in the investors' own currency, so you avoid the extra cost of doing currency exchange. However, be aware that the price of the product in your currency will fluctuate with the combination of index development and exchange rates. The trading commission will usually be the same as for trading shares with your broker. Bid and offer prices in the trading products are set by market makers (in practice a monitored computer that ensures that the price of the product reflects the price of index futures and currency). Most often, the spread (difference between the purchase and sale price) is low and lower than for most single stocks. The volume made available on the buy and sell side is also generally large, and much larger than in most shares. Check for yourself. It is usually unproblematic to take on and off positions of several million if you want to.

Some brokers do not offer trading in index products, or you have to search a bit in the product range to find them. Contact your broker for more information about what is available to you. As said above, it is extremely important to familiarize yourself with such products before you trade them, but trading indices rather than shares may be worth looking into. Many professional traders and hedge funds trade almost exclusively index, and I am one of them.

Disclaimer: After more than 20 years in the brokerage industry I started my own business in 2021. I published the book "Paleo Trading: How to trade like a Hunter-Gatherer” and launched Paleo Capital that manages a hedge fund according to the principles described in the book. I emphasize that nothing written on this blog is to be regarded as personal advice or a concrete call to take positions. Everyone must be responsible for their own decisions and familiarize themselves with the products they use.