Every day, serious and curious investors are bombarded with thousands of newsletters, analytical market reports, radio and television investor programs and segments, newspaper articles, and friendly tips, all based upon the same thing. That thing is the study of the supply and demand in a market or stock exchange in an attempt to predict what direction or trend will continue into the future.
In this section the practical investor will come to a better understanding of the emotions working in various markets. The investor will realize why watching the stock exchange minute by minute is not necessary for long-term investors, that different world markets do not operate in unison with the market one is usually active in, and what the most commonly quoted stock exchange indexes really tell us and how to use them.
Stock Exchange Indexes Explained
A stock market index is a listing of selected stocks, statistically expressed to reflect the composite value of its component stocks. As an investment tool, it is a representation of its component stocks, all of which share a mutual characteristic such as trading on the same stock exchange, belonging to the same industrial sector, or being in the same capitalization range or economic size. There are different ways to calculate index numbers but all represent a change from an original or base value.
What does that mean for the individual investor? Indexes do give investors a feel for the direction of the particular market the index represents. That does not mean an individual stock the investor happens to be carrying in his portfolio is going to move in the same direction or at the same rate, but it does add another useful tool to work in tandem with the share price valuation process. It is important to note that most indexes only represent a sampling of the total market and infer an attachment to the market and economy in general. Even with their limitations, indexes show trends and changes in investing patterns. Indexes provide a yardstick of comparison in a way.
Important North American Indexes
In Canada, most investors are primarily concerned only with what is happening within the Toronto Stock Exchange, and the New York Stock Exchange. This is where most of the money goes and it is easier to keep a pulse on what is happening in these centers. Of the myriad of charts, indexes and trend analysis put before investors, only a few are of any real value to the vast majority of practical investors and these are the ones we are focused on here. There are a number of other indexes that measure larger or smaller sections of the market. However, the major three US indexes and well known Toronto index which follow will serve most investors well.
S&P / TSX 300 Composite Index
The TSE 300 Composite Index is a benchmark used to measure the price performance of the broad Canadian equity market. Introduced in 1977, the TSE 300 Composite Index is maintained by Standard & Poor’s. It includes 300 of the largest publicly traded companies on the Toronto Stock Exchange and is regarded as a barometer of activity in the Canadian markets. Standard & Poor’s reviews and follows strict criteria for a company’s inclusion in the TSE 300 and makes changes accordingly.
The Dow Jones Industrial Average
The Dow Jones Industrial Average is the oldest and most widely known index. It is also the most widely quoted index and believed to mistakenly be considered the market barometer. The Dow has roughly only 30 stocks. The industrial portion of the name is historical and these days the index has little to do with heavy industry. However, each of these stocks represents one of the most influential companies in the U.S. and all have annual revenues in excess of $7 billion. The Dow stocks represent about one quarter of the value of the total market, so in that sense it is a factor and big changes indicate investor confidence in stocks, however it does not represent small or mid-size companies at all.
The Dow is the only major index that is price weighted, which means if a stock’s price changes by $1, it has the same effect on the index regardless of the percent change for the stock. In other words, a $1 change for a $30 stock has the same effect as a $1 change for a $60 stock. The Dow is widely criticized because this gives relatively higher-priced stocks more influence over the average than their lower-priced counterparts, even though the first stock in the above example experienced a larger percentage change.
The S&P 500
The S&P 500 is the most frequently used index by financial professionals as a representative of the market. It includes 500, or almost 10% of the entire market, the most widely traded stocks and leans towards the larger companies. It covers about 70% of the market’s total value, so in those terms it is much closer to representing the true market than the Dow.
The S&P 500 is a market capitalization or market cap weighted index, as are almost all of the major indexes. Weighting by market cap gives more importance to larger companies, so changes in the corporate giants will have a greater impact than almost any other stock in the index. Despite being weighted toward larger companies, it is a more accurate gauge of the broader market than the Dow is. Even though so much of the media attention may emphasize the Dow, investors will get a clearer picture of the market by focusing attention on the S&P 500.
Stock Market Composite is composed of all the 5000 or more stocks on the NASDAQ market. Although broad in coverage, the NASDAQ is heavily weighted to technology stocks. This is because it is a market cap weighted index and stocks of big technology companies influence the index. Their influence and the population of small, speculative companies in the NASDAQ make the index more volatile than either the Dow or the S&P 500. The NASDAQ obviously is not designed to represent the market however it does give you a good idea of where technology investors are going at the stock exchange.
Specialty Markets CNQ
CNQ is an innovative new stock exchange for trading the equity securities of emerging companies. CNQ’s unique market model matches enhanced disclosure and streamlined issuer regulation with leading edge technology and comprehensive regulatory oversight to meet the needs and characteristics of emerging companies, their investors and investment dealers. This is the description taken from the CNQ information brochure. Most shares traded on this stock exchange are centered on natural resource companies.
TSX Venture Exchange
The TSX was previously known as the Canadian Venture Exchange. The venture stock exchange was founded to restructure the Canadian Capital markets along the line of market specialization. The focus is on junior companies whose assets, business and market capitalization is too small to listed on the regular Toronto Stock Exchange.
Stock Exchange entities such as these provide companies an avenue for raising the capital they need to move forward with new products and new ideas. For some, it is just the opportunity needed to burst into the next level while for others, the market is not convinced of their viability and turns them down. For the speculative investor, small cap markets represent an exciting opportunity to find the next boom company wave to ride.
For the purposes and ideals of the practical investor, constant awareness of the volatility in these markets should be maintained while applying the same analytical tools used to evaluate blue chip securities. Like the two in Canada mentioned here, there are numerous similar stock exchanges in other parts of the world. Now, you know they thrive and exist.
On volume, the Toronto Stock Exchange is about the sixth largest stock exchange worldwide, there are hundreds that are smaller. It is not within the scope of this tutorial to examine in detail all the aspects and opportunities for investors participating in major world stock exchange markets. One of the basic rules of good investing is diversification. This strategy enables investors to reduce their level of risk by spreading their money over a selection of different types of investments or various bodies of stock exchange. Considering Canadian stock exchange markets represent only 3% of all the world stock markets, investing outside of Canada can provide a higher return with a lower level of risk.
The performance and amount of activity in markets such as Nikkei and Hang Seng in Asia have provided exciting opportunities to world investors. The FTSE stock exchange markets in the UK and DAX markets in Germany trade in tremendous volumes Canadian investors should be aware of.
There is always something happening around the world. When the economy or stock exchange markets are flat in North America there could be extended periods of gain in Europe or boom in Asia. Keeping abreast of it all is a very difficult task, but the point to make here is for investors to open their eyes to a world of opportunity. Perhaps consider a mutual fund that is invested internationally as the easiest, most secure way to take advantage of foreign stock exchange markets.