21 May
Don't waste your money
Here are the investments that make a difference
Each asset that makes up the index is unique and has characteristics that can maximise our risk/reward ratio, just by buying and selling at the right time.
One of the most common mistakes when trying to invest in a stock market index is to focus on instruments that replicate their performance, such as mutual funds, ETFs or CFDs.
It should be borne in mind that investing in the entire list necessarily entails exposure to risk, in the absence of diversification, multiplied by the number of companies in the same sector that it contains. Investing in a stock market index based on the given construction, without evaluating individually the momentum that constitutes the companies that compose it, essentially means losing the opportunity to optimize returns in the short term, considering the entire list equivalent to its individual components.
What are the most important stock indices?
The most important equity indices are those of the United States, as the politics and economy of the US still represent the world’s benchmark and guide for international decision-making. So, too, the stock indices, which largely represent its economic power, are the added value capable of driving capital with increases that, if evaluated over the long term, are largely capable of meeting investors’ expectations.
However, it is possible to note that the number of companies that make up the indices is not a guarantee of diversification or protection from risk, nor is it a guarantee of proportional profits, becoming only an obstacle to profits deriving from the impossibility of active management when the number of companies that make up the indices is excessively high.
The best stock indices on which to trade
Dow Jones Industrial Average
Dow Jones Industrial Average, better known simply as Dow Jones, second in foundation only to the NYSE which was created in 1792, is the historical index of the New York Stock Exchange. One of its founders, Charles Dow, was also a pioneer in technical analysis, with his studies of stock market cycles, thanks to which it is still popular today and is studied in trading manuals as a fundamental way of understanding how financial markets work.
Charles Dow and his partner Edward Jones created the index in 1896 by including the 12 most representative companies of the economy at the time. At that time, the North American economy was particularly developed in the railway sector, in sugar, cotton and tobacco plantations, as well as in the extraction of raw materials such as gas and oil.
Today, the index includes the top 30 companies in the US stock market according to a weighting based on their share price, thus representing their capitalisation. The index is of course updated according to the share price movements of listed companies, and is therefore susceptible to change according to economic and financial cycles. The oldest currently listed company only dates back to 1976, with the last updates being made in 2020.
- Average return over the last 10 years (2010-2020): 11.8% per year
- Negative years: 2
- Maximum drawdown: - 5.63% (2018)
- Maximum return: 26.5% (2013)
The Standard & Poor's 500
The Standard & Poor’s 500 Index is perhaps the most popular of the indices created by the S&P Global ratings agency. While before 1957 it only listed 90 companies, today it is the benchmark index of the US stock market, with a basket comprising the 500 most important American companies in terms of capitalisation and financial rating.
This index was created not only on the basis of the share values of listed companies, but also on the basis of their liquidity and free float, the amount of shares that can actually be traded on the market. This makes it particularly suitable for those investors who are well capitalised and able to invest without necessarily affecting the value of the shares.
- Average return over the last 10 years (2010-2020): 15.8% per year
- Negative years: 2
- Maximum drawdown: - 6.24% (2018)
- Maximum return: 28.88% (2019)
The Russell 2000 Index
The Russell 2000 Index is an index that is particularly well suited when you want to invest with a risk appetite profile, considering the performance in terms of growth, which can be achieved on the stock market.
Compared to the indices described so far, which took into account the most financially important US companies, these, on the contrary, despite their economic importance, are small to medium-sized companies, unlike the giants listed on the Dow Jones and S&P500. For comparison, the Russell 2000 index represents only 10% of the capitalisation of the Russell 3000 index, which more traditionally quotes the largest capitalisation companies in the US.
This index, which was founded in 1984, is also very useful for becoming aware of the risk and return limits that can be achieved compared to the performance results we have observed on capitalisation-weighted indices.
- Average return over the last 10 years (2010-2020): 14.9% per year
- Negative years: 3
- Maximum drawdown: - 11% (2018)
- Maximum return: 26.85% (2010)
The NASDAQ 100
NASDAQ, based in New York, was founded in 1971. Its acronym, National Association of Securities Dealers Automated Quotations, refers to its special nature, as it was the first stock market in the world to be managed entirely through a computer network.
When trading was still conducted in a chaotic environment, the exchange provided a telematic intermediation service between investors, facilitating the meeting of supply and demand and making exchanges accessible through market makers, who took orders from traders who no longer had to physically visit the stock exchange. It later became the first stock exchange to offer an online trading service.
The NASDAQ 100 comprises an index of the largest non-financial companies listed on the NASDAQ Composite Index. Most represent companies in the technology, computer, electronics and telecommunications industries.
It can be said that this is the best index for active trading among the most accessible ones, offering a first selection of companies listed in the US indices. And as the data show, the limited number of companies that make up the index does not present any disadvantages, even if you want to remain invested for the long term.
- Average return over 10 years (2010-2020): 22.2% per year
- Negative years: 1
- Maximum drawdown: - 1.04% (2018)
- Maximum return: 47.58% (2020)
