Ever wondered if there was a way to gauge the performance of the stock market without rummaging through hundreds of individual stocks? Well, this is where indices come into play. But then again, that begs the question, what are indices? Statically speaking, it’s a measure of performance of all stocks grouped according to their similarity. The selection criteria can vary but in the Australian exchange, it is based mainly on three main factors:
- The total size of the company from which the stock is derived.
- The total market capitalisation.
- The type of industry that the company is based in.
Any change in the market will reflect on these indices and their value moves accordingly. As the price of underlying securities rises, so does the index. If they go down, the index plummets with it.
Different Types Of Indices In The Australian Market:
The aforementioned explanation has now satisfied the question “what are indices?”. The Australian stock exchange holds various types of these indices which investors can look into:
- Indices based on the bond market performance and the short term markets for money. They are labelled under “fixed income”.
- Based on the performance of how rule-based strategies for investments fare, these indices come under “strategy”.
- Indices based on various sectors in the stock markets, the performance is labelled under “sector”.
- Indices that represent the market volatility, reflecting the sentiments of investors. The label is “volatility” and usually represents a near-term approach.
- Finally, the major indices that represent the market capitalisation of companies are labelled under “capitalisation”. Higher market capitalisation is indicated by higher index weights in percentage and lower capitalization will show lower percentages.
Price based indices will make use of a company’s share price to gauge its value on the indices. Higher share prices will reflect higher influences on the indices compared to companies having lower share prices.
The Importance Of Indices In The Australian Stock Market:
1. Benchmarking: The performance of the indices in the stock market can help investors and traders analyse how well their trades and investments fare. By comparing the performance of stock indices with that of the actual stock performance in a particular portfolio, investors can accurately measure the total performance within a certain period. As a result, various participants in the market can use indices to check any important information or make predictions about the market performance.
2. Indices Help Mitigate Risks: By using index funds to indirectly invest in indices, investors can diversify their portfolios and spread out the risk evenly. Since the risk of performing below the standards for profit is very low, risks involved through indirect investments by way of indices are manageable compared to direct stock investments in a specific company. This is a reliable advantage that can be attributed to the diversity of stocks from several industries and companies.
3. They Are Ideal For Long Term Investors: Cherry picking the best-performing stocks is no walk in the park. It involves a lot of work and market research before investors decide to stake their money in any company. For passive investors the case is different. Since they don’t have the time to research the market, stock indices offer them an avenue for long term growth without looking up their portfolios all the time. Through investments of indices, individuals can save a lot of time and effort without compromising the investment quality.
Since indices offer a wider exposure to cushion the risk, poorly performing companies that may make up a particular index may not necessarily reduce its value. Index values can still rise even during improper performance owing to the weight of market capitalisation or other factors. For those looking to diversify their portfolios, banking on indices might be a good start.
