What Is an Equity Index and How Does It Work?

Over the past couple of years, equity indices have grown in popularity as investors and traders seek to gain exposure to a plethora of companies' price swings without having to trade each stock individually.

So what are indices exactly, how does a stock index work, and how is it calculated? Here's what you need to know about equity indices:

TL;DR

• An equity index is a collection of stocks grouped by factors like market cap, sector, or geography to track overall market or sector performance.
• Indices provide a snapshot of how markets or sectors are performing without analyzing individual stocks.
• Types of Indices:
  • Broad Market: Tracks a large portion of the market (e.g., Russell 3000).
  • Multi-Market: Tracks multiple countries or sectors (e.g., S&P 500).
  • Sector: Focuses on specific industries (e.g., tech, healthcare).
  • Style: Categorizes stocks by market cap, value, or growth (e.g., FTSE UK Dividend Plus).
• Indices track market sentiment, measure portfolio performance, and allow easier diversification.

Equity Index Defined: What Is an Equity Index?

In short, an equity index is a compilation of stocks from different or similar market segments. The stocks are compiled together based on factors such as market capitalization, geography, or market sector, among other things.

How Do Equity Indices Reflect Market Performance and Trends?

Indices can be useful tools for traders, as they give them an overview of market performance. This is because stock indices gauge how certain sectors function as a whole, which means that traders do not have to look at individual stocks to do so.

Traders may also use equity indices, such as the S&P 500, to compare their portfolios to the index. In addition, investors may want to better grasp a particular stock sector or outperform it, referring to sector indices.

Types of Equity Indices

There are multiple types of equity indices to keep in mind, and these are as follows:

• Broad Market Indices: As the name implies broad market indices represent an entire market and usually make up more than 90% of a certain market. A good example of this would be the Russell 3000 which tracks the performance of 3000 of the biggest US companies, and as such, comprises about 95% of the US equity market.
• Multi-Market Indices: Usually indices from various countries that represent multiple market sectors are considered multi-market indices and these include the S&P 500.
• Sector Indices: Sector indices are those that measure stocks from different sectors and can act as a good indicator of whether the economy is faring well or not at certain points in time. These sectors can range from industrial to technology and consumer products to healthcare and energy and a good example of such an index would be the S&P 500 Information Technology Index which measures information technology companies' performance.
• Style Indices: Style indices refer to the stocks that are categorized into various groups based on their market capitalization, value, growth or a combination of these factors. As such, a style index provides a benchmark for a certain style. This is similar to how indices like the FTSE UK Dividend Plus and MSCI style work.

How Are Equity Indices Calculated?

There are two main ways through which equity indices get calculated:

• Price-weighted index: price-weighted indices take the companies' price per share and calculate the average. Moreover, this type of index value is more affected by companies with higher prices.
• Value-weighted index: value-weighted indices or capitalization-weighted indices track the prices of the stocks on them based on their market capitalization. This means that these indices take into account the total market valuation of the stocks they track.

Significance of Equity Indices

Equity indices can be significant because they are good indicators of overall market sentiment, traders can use them to measure the performance of their portfolios and investments, and they can help traders diversify their portfolios.

Trading Equity Indices

Given their important and helpful role, traders and investors may naturally seek ways to invest in equity indices. Various methods, including CFDs and ETFs, can be used to invest in and trade indices, which may be suitable for traders looking for short-term gains.

Conversely, those seeking to profit in the long run may find Equity Index Futures more attractive.

What Are Equity Index Futures?

Equity index Futures are derivative agreements between two parties that allow them to speculate on the future prices of the underlying index in question. These contracts obligate the involved parties to settle the contract at a predetermined price in the future. You can find out how Futures contracts work in our article "What Are Futures and How to Trade Them?"

To conclude, equity indices may be a good solution for traders and investors seeking to gain exposure to various stocks and market sectors without having to trade each stock on its own. These may also be a good way for traders to gauge the overall performance of the market and certain stock sectors. Plus500's Futures trading platform offers Futures contracts on equity indices.

Conclusion

Equity indices provide a comprehensive way to track overall market performance and sector trends. They allow traders and investors to diversify their portfolios without managing individual stocks. Whether you're trading for short-term gains or long-term investments, there are different methods like CFDs, ETFs, or Futures that suit various trading styles. Using platforms like Plus500 for Futures contracts on equity indices can provide exposure to broader market movements.

Now that you have learned about Equity Indices, you can start trading Equity Index Futures with Plus500.