When we begin our investment training we may have a predilection for a specific asset class. It may be that we like the investment in stocks, in currencies, in raw materials, cryptocurrencies... or in indices. The latter are the typical ones that we can observe in the news, which can guide us on how assets from different sectors or markets are performing. Have you wondered how they are made up and what they base their price on? We are going to dedicate this investment training to breaking down the indices in depth to be able to operate them efficiently.
What are indices?
Indices are a group of assets that are used to track the collective movements of a specific sector. Each index has its own type of composition, but by default they are all expressed in points and not in currencies, just as other asset classes do. That is why we cannot invest directly in indices. To do this, we can use derivative products such as futures, CFDs and ETFs. With these products we can invest in the indices without having to buy all the assets that comprise it. We can find different types of indices, from stocks, raw materials or currencies. And how is the value of these indices calculated? Let's follow the training in index investing to find out...
How are the indices composed?
As we mentioned in the previous paragraph, the indices are measured in points, which fluctuate based on the prices of the shares or assets that comprise it. These points help us visualize market movements and be able to define the trend. To measure the profitability of an index, we have to do so from the base point, that is, the price at which the index was launched. These points depend on asset prices and there are several ways to calculate them. Mostly the indices are calculated following the two types of calculations that we will show below in this investment training. Let's see what the calculations are:
Unweighted asset price index
Indices that are calculated based on asset prices (Price-Weighted Index) are the most common that we can observe in our index investment training. These indices base their calculation on the sum of the prices of the assets that make up the index. Next, we divide the result of this calculation by the total number of assets in the index, that is, an arithmetic average based on prices. This type of index gives more weight to assets that have a higher price. Therefore, assets with higher prices can make the index grow even if other assets in the index lose value in turn. Let's give a practical example creating the Fi index to make this investment training more efficient:
Example of a price-based index. (The values of the Fi index are fictitious to explain the example)
The Fi index is made up of 5 companies invested within the Academy's investment community. In order to discover the value of this index by prices, we first add the price of the companies' shares (7+10+9+15+3=44). Next, we divide the number obtained (44) by the number of companies that make up our index (5). With this calculation we discover the value of our index, equivalent to 8.8. As we see, Superfluid tokens weight 34,09% of the index, therefore, the valuation of the index will be highly exposed to the prices of these specific tokens.
Market capitalization weighted index
Let's continue with the training in index investing with the second most used calculation to define the value of an index. The second calculation is based on the market capitalization of the companies that comprise it. First of all, the market capitalization of an asset is achieved by multiplying the number of shares outstanding multiplied by the current price of its shares. In this way we can know the market value of the company's shares/assets. Let's give another example to facilitate the understanding of this part of the index investment training:
Example of a market value-weighted index. (BTK index values are fictitious to explain the example)
In this example, we have created the BTK index, weighted by market value. This index is mainly composed of assets in beToken Capital's portfolio. We have already done the calculations to discover the market capitalization of the different assets, then we add all the values of the tokens and get the total market value of the index. As we can see, the weightings in this case are different from those based on price, since it gives more weight to the assets that have the highest market value. For example, The Graph is the asset with the highest price ($15) but its weight in the index is 5,43%. On the other hand, the most heavily weighted value in the index, DyDx ($9), is the third highest priced token of the five assets but has the highest market value of all. For this reason, the movements made by DyDx can have much more influence on the value of the index than the others, since it has 42% of the weight of the index.
What differences can we find between these two types of indexes?
At first hand, the main difference lies in the calculations on which each of the indices are based. While the first gives more weight to the assets with the highest price, the next weighs their values on the market capitalization of the assets that comprise it. The difference between the index calculations can end up influencing the results of the index due to the weight given to each calculation. We are going to expose these differences based on the table of the last index that we have created in this investment training:
Profitability of the BTK index after 3 months. (BTK index values are fictitious to explain the example)
Initially, the BTK index had a market value of $276 million and an average token price of $8.8. Let's say it's been 3 months since we created the index and we come across these numbers. The market value has dropped to $272,25 million, while the average token price has risen to 9,01. So, if we measure the variation with the weighted calculation, we get a loss of 1,36% (referring to the fall in the total market value of the index). On the other hand, if we do not apply the weighting and rely on the arithmetic average of prices, the index would experience a rise of 2,39% (referring to the rise in the average of the token prices). Therefore, the results as we have seen can vary significantly depending on how the value of the index is calculated.
What are the most popular indices globally?
As we mentioned when starting this training on indices investing, we can find different types of indices, of which we are going to explain the most popular ones below:
Stock market indices
Stock market indices are those that are made up of a basket of stocks from a specific country or sector. As we have been explaining, its value is mostly calculated weighted by market capitalization (like the S&P 500 or the IBEX-35) or by applying an arithmetic average of prices (like the Dow Jones Industrial). And which are the most popular in each region of the world?
America
The most popular indices in America are those of the US. From the North American part we can highlight the Dow Jones Industrial Average (industrial sector/DJIA), the S&P 500 (500 best American companies/SPX), the Nasdaq 100 (technology sector/NDX) or the Russell 2000 (small capitalization stocks/Passport). Of course, North America is not just the US (as they usually believe...), since we can also see the TSX (Canada/TSX). They also have the famous VIX index (VIX), which is widely known in the investment world as the fear index. This index measures the volatility of the S&P 500 and is usually related to the sentiment in the financial markets.
In the South American region it houses indices composed of companies largely exposed to raw materials. The most popular indices in the South American region are the ICAP (Colombia/ICAP), the Bovespa (Brazil/IBOV), the S&P IPSA (Chile/SP_IPSA) the S&P Merval (Argentina/IAR), the S&P BMV (Mexico/ME) or the S&P BVL (Peru/SPBLPGPT).
Asia and Oceania
Within the Asia and Oceania regions, the most popular indices in those regions are indices such as the Hang Seng (Hong Kong/HK50), the Nikkei 225 (Japan/NKY), the Kospi (South Korea/KOSPI), the CSI 300 (China/000300), the Nifty 50 (India/Nifty) or the ASX 200 (Australia/ASX200).
Currency indices
Currency indices are designed to measure changes in the value of the currency. This is done by tracking the exchange rates of the most liquid currencies in the market. The US dollar index (Dxy) is the most popular and most traded currency index. We can also highlight the euro (EXXY), that of the British pound (BXY), that of the Swiss franc (SXY), that of the Japanese yen (JXY), that of the Canadian dollar (CXY), that of the Australian dollar (AXY) or that of the New Zealand dollar (ZXY).
Commodity indices
And to finish this training in investment on indices, we can also find indices of the raw materials sector. One of the most prominent commodity-based indices is the S&P Goldman Sachs Commodities Index (SPGSCI), which was launched in 1991. This is the reference index for raw materials, since it is made up of a wide range of raw materials from different sectors. We can find dozens of other indices from different entities (BNP, DJ, NQ or SGI), but that of Goldman Sachs is the most diversified of all.
Most important events that the S&P GSCI has experienced. Source: SP Global.
Conclusions from this index investment training
After having given a good review of what indices are, we have learned what they are, how their values are calculated and the different types of indices that we can find. The ease it gives us by being able to invest in a wide variety of assets in the same sector without having to buy them all directly is one of its highlights. As weaknesses we can highlight the two types of calculations to value the indices, given that in certain situations, when an index is highly exposed to few assets, it can monopolize the movements of said indices. In turn, we have visualized the main indices of the world's regions along with currency indices to measure the strength of the main global economies. And to finish this investment training, always remember that indices do not set their value in currencies, they do so from a fixed base and in points.
European Union
On the old continent we also have investment opportunities in indices. The most popular are the Dax 30 (Germany/DAX), the Ibex-35 (Spain/IBC), the CAC 40 (France/CAC40), the FTSE MIB (Italy/FTSEMIB), the AEX (Netherlands/AEX) or the Stoxx 600 (Europe/SXXP). Previously we could include the FTSE 100 (United Kingdom/FTSE100), although they are no longer part of the European Union.
Asia and Oceania
Within the Asia and Oceania regions, the most popular indices in those regions are indices such as the Hang Seng (Hong Kong/HK50), the Nikkei 225 (Japan/NKY), the Kospi (South Korea/KOSPI), the CSI 300 (China/000300), the Nifty 50 (India/Nifty) or the ASX 200 (Australia/ASX200).
Currency indices
Currency indices are designed to measure changes in the value of the currency. This is done by tracking the exchange rates of the most liquid currencies in the market. The US dollar index (Dxy) is the most popular and most traded currency index. We can also highlight the euro (EXXY), that of the British pound (BXY), that of the Swiss franc (SXY), that of the Japanese yen (JXY), that of the Canadian dollar (CXY), that of the Australian dollar (AXY) or that of the New Zealand dollar (ZXY).
Commodity indices
And to finish this training in investment on indices, we can also find indices of the raw materials sector. One of the most prominent commodity-based indices is the S&P Goldman Sachs Commodities Index (SPGSCI), which was launched in 1991. This is the reference index for raw materials, since it is made up of a wide range of raw materials from different sectors. We can find dozens of other indices from different entities (BNP, DJ, NQ or SGI), but that of Goldman Sachs is the most diversified of all.
Most important events that the S&P GSCI has experienced. Source: SP Global.
Conclusions from this index investment training
After having given a good review of what indices are, we have learned what they are, how their values are calculated and the different types of indices that we can find. The ease it gives us by being able to invest in a wide variety of assets in the same sector without having to buy them all directly is one of its highlights. As weaknesses we can highlight the two types of calculations to value the indices, given that in certain situations, when an index is highly exposed to few assets, it can monopolize the movements of said indices. In turn, we have visualized the main indices of the world's regions along with currency indices to measure the strength of the main global economies. And to finish this investment training, always remember that indices do not set their value in currencies, they do so from a fixed base and in points.