Trader Guide To Equities
Now we have quick question here from Kevin asking why exactly some equity markets sometimes move in congruently.
And we also had a question in today’s webinar from Nick, asking why we can sometimes choose one index above another. And the most common answer, Kevin and Nick with regards to these type of questions can be found by looking under the hood of some of the equity indexes and understanding their composition.
RECOMMENDED READING TO FURTHER UNDERSTAND EQUITIES:
Now, I mean, this video, we won’t have time to go over each and every one of the single indexes but what we will do is we will go over the most important parts to look for with a couple of practical examples and then once you know the process that we use for looking at them, you can obviously you know, I encourage you to do your own research on those major equities through the lens of this video in this process, as it will help you to better understand how these equities move and why.
Now the first thing to consider or understand about indexes are that they they simply track stocks, right? It’s a share index or stock index. And so it’s basically just a bunch of stocks piled together to track how an economy or particular sector of the economy is doing.
So when we strip away all the, let’s call it the fluff and get down to the bare bones, there’s essentially only three things that we need to know about each index, namely, what is the country that it represents?
What is the sector waiting for the index? And then what is the top, let’s say three or five or 10 companies, depending on how the index is weighted? For example, looking at the top three US equity indexes, of course, everybody will know the S&P 500, the Dow Jones 30, and the NASDAQ 100. Now the number in each of the names basically represents the amount of companies in the index.
But keep in mind, some companies might have dual listings like Google, for example, you’ll have Google, you’ll have Alphabet, which means that they might be 101 or 102 stocks, actually in something like the NASDAQ 100. Now, what we do or what we need to know about these three things, we can go back to that list of three things.
So firstly, what country do they represent? Of course, these three represent the United States and companies in the US. And let’s go to the second one, what is the sector waiting? Now, going down to the granular level and knowing the entire index composition is really just not that important. Knowing the let’s say the top one or two or three sectors, depending on the size obviously, is usually enough for us to know.
So looking at something like the NASDAQ, for example, it’s got a very ITO technology heavy weighting as sitting at almost 50% of the index, which is followed by a consumer services at 20%.
So very tech heavy index with the top five names being Microsoft, Apple, Amazon, Google and Facebook. And of those five names the first three make up over 30% of the index itself. So the index is very sensitive towards to regarding the tech sector and it is market capitalization weighted. So it means that those five companies or six companies can make up the vast majority of the overall index.
So if we see a big move in the technology sector, for example, or just in one of these five names, we can expect the index to be affected. So if you have massive news coming out about Facebook, for example, or Apple, or Amazon, you can expect that to affect the NASDAQ. And you can expect that to affect something like the NASDAQ more than the Dow Jones just as an example. So any big divergence in some sectors can see different impacts in the equities.
So looking at the NASDAQ, another important thing to remember is that the NASDAQ doesn’t have any financials or oil and gas names. So any big divergences in oil and gas names might affect the S&P, but it might not necessarily affect the NASDAQ. So turning to something like the Dow Jones, again, it’s not a market cap weighted like the NASDAQ but actually price weighted, so it’s not about the size of the company in terms of market cap, but the actual shape price that matters for the Dow Jones. So the top five stocks in the Dow can really affect the overall index due to the share price value. So looking at Boeing, Boeing consists of 9% of the index then you have UnitedHealth at 6%, Home Depot at five, Goldman at five, McDonald’s at 5%. In the Dow Jones due to its share price composition, it’s its top sectors are industrials, that comprises about 20% of the index and IT sitting at just under 20 at 19%.
So, very important to know how that top five companies will be able to move the Dow so if you see the Dow dropping or rising and you don’t see any of that type of move in the S&P or the NASDAQ, it might just be something happening to Boeing specifically or to McDonald specifically. So turning to another part of the world, let’s look at something like the European indexes. We have the DAX 30 of course we have the Euro Stoxx 50 and we also have something like the Footsie 100 which I don’t have on the charts here at the moment.
So let’s go back to those first three questions which countries do they represent? Obviously the DAX 30 is the 30 biggest countries represented in Germany.
They are also market cap weighted, looking at the Euro Stoxx it’s going to be for the whole Euro area, but due to company, the company’s the biggest companies in Europe being in Germany and France, it is France and German weighted and looking at the Footsie 100 for example, that represents the hundred biggest companies in the US.
So obviously, we know what the countries are, then what are the important sectors and each of them? Well, if you look at the decks, normally automobiles are associated as the biggest influence of for the decks, and even though it does comprise of about 10% of the index, the biggest component is actually materials. And the biggest companies are companies like SAP or SAP, Siemens, Bayer and Daimler so any major health or pharmaceutical changes who forgot to do the names like Bay et cetera. Can have a big impact on the DAX apart from just auto names turning to something like the Euro Stoxx 50.
As we said it’s mostly French and German companies it is more balanced in terms of the sector weighting. But it is more exposed to banks and the banking sector. So if you’ve got any major stresses with regards to Italian debt or or a real sovereign crisis in terms of debt, then that should normally affect something like the Euro Stoxx more compared to something like the DAX. Then looking at the Footsie 100, the term Footsie or FTSE sounds strange, but it’s just an abbreviation for the Financial Times Stock Exchange. So the Footsie 100 represents the top 100 companies in the UK and it’s almost 80% I think the last time I checked off the total market cap of the entire London Stock Exchange.
So a very big weighting in terms of it’s important. Now the sector weighting year is quite interesting. It’s very oil and gas heavy at almost 20% and then followed by banks, and also at 12%. But that shouldn’t really be a surprise of companies like shell and BP or British Petroleum. So oil and gas and banks like HSBC and Barclays whenever we have big oil news or big banking news, of course that can affect the Footsie 100 more compared to something like the DAX.
Now to your question on why the index has moved differently, this answer should give you more an idea as to why that sometimes happened. The three things that should be that we should always ask what country what sectors, what companies that should be able to answer most of those questions, if you see any one of them moving differently to one of the other, ask what is, is there something specific happening to the country?
Is there something specific happening in the most weighted sectors? Is there something specific happening in the most important companies? If you know those three things, you’ll see why some of these tend to move differently. So how can all of this help you as a Fx trader?
Well, we don’t look at these indexes in a vacuum, right? We always look at them through the lens of the overall market sentiment to tell us whether the market is leaning more risk on or risk off.
Now, of course, when something major happens with a major company, or within a major sector that will firstly affect the performance of the related index. But the bigger the news is, the bigger the impact it can have on the overall equity space. So that’s why it’s important for us as FX traders. For example, when we have very positive or negative news for companies like Apple or Amazon, it might have an initial bigger impact on the NASDAQ and maybe the S&P 500. But due to the importance and the role as benchmark indexes, they might spill over into the other equities, which can affect the overall mood of the market.
So knowing when big news affects one index, and whether that news can potentially affect the others, it’s important for us from a risk sentiment point of view as FX traders.
So knowing what might affect these indexes is helpful and to us as FX traders, because it can give us some context as to why certain markets are moving the way they do and whether that sentiment that is driving and is being an important enough to spill over into the overall equity markets and of course ultimately affect the various asset classes if we see strong risk on and risk of flow.
So Kevin and Nick, I hope this video is helpful for you guys.