fbpx

Types Of Markets Part 2: Index vs Shares

Why some traders prefer trading Indexes instead of Shares.

An index is a collection of shares that are traded with their cumulative percentages together making up an index. To trade the shares, you would have to trade each share that makes up the index individually in order to outperform that index. That can be quite difficult in cases such as the S&P 500 as there are 500 shares in that index, 100 shares in the NASDAQ and 30 Shares in the DOW Jones Index. This means that traders would have to be in multiple open positions for a long time and it can take a lot of brain power to do this. Most traders trade the indexes because the workload is less, and the index tends to outperform individual shares. There might be a small percentage of successful traders who will buy the top 5 shares and hold their positions to make larger percentages but that is not common – as a general rule an index will do better than an individual share.  

Basically, traders trade indexes because it is easier to maintain positions, and when prices drop it will be a smaller percentage than shares since shares are able to drop and climb a lot faster and at a higher percentage. So, risk and reward are higher in the index than on the individual shares.

Shares can be traded to make more money, but it comes with higher risk because of the spread and its ability to drop in price drastically as seen in the below image of the Anglo-American share price that dropped 19% in 20 days. Larger shares influence the index at a greater percentage, but it will only drop so far before the price of the other shares counterbalance the drop. It also depends on the index as some are structured so that every share has equal influence over the index while others allow for the top 5 or 10 shares to have far more influence than the rest of the shares in the index.

The index is just easier because the risk to reward is far less than trading shares.

 

As traders get better and cashflow is higher they start trading shares to make more money, to diversify and to spread the overall risk.

Leave A Comment

This site uses Akismet to reduce spam. Learn how your comment data is processed.

No products in the cart.

X