What Is an Equity Index and How Does It Work?

Date Modified: 10/01/2024

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:

An illustration of an equity index trading charts and graphs

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 to 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 portfolio to the index. In addition, investors may want to get a better grasp on a particular stock sector or want to outperform it, referring to sector indices.

Significance of Equity Indices

Equity indices can be significant due to the fact that they are good indicators of overall market sentiment, they can be used by traders to measure their portfolios’ and investments’ performances, and they can help traders diversify their portfolios.

Trading Equity Indices

Given the important and helpful role they play, traders and investors may naturally seek ways to invest in equity indices. Investing and trading indices can be conducted through various methods, including CFDs and ETFs which may be suitable for traders looking for short-term gains.

On the other hand, 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.