Stock indices are extremely popular with traders and investors. They are used to speculate and hedge against stock portfolios, especially during any potential downturn.
Part of the attraction of stock indexes is that they remove the need to research individual companies, as they are only an index that tracks a pre-defined basket of stocks. Therefore, index-based investing is based on a more overall perception of how the stocks listed in the index will perform. It is worth noting that corporate titans such as Apple have a major impact on the indexes that are based on capitalisation or share price, just because they are so large.
A sector-based approach
However, there is another way to trade a stock index which is by sector. These are available on various indices such as the S&P 500 and Eurostoxx and allow a trader to be more selective. An index often will have certain sectors perform well but this may have a negative impact on others.
Consider when Covid hit in 2020 and we were confined; tech stocks rallied as we all used the internet for work and entertainment, as well as utility resources such as water and electricity, and of course, the pharma sector as they sought to develop and produce vaccines. Lockdowns negatively impacted sectors such as airlines, travel, hospitality, real estate, the auto industry, and construction.
By trading sectors, you could have maximised profits from being long some of the sectors and short others, however, overall pretty balanced or with a net zero delta position.
In Europe, there was a great opportunity a few years back when the car industry was hit by accusations of emissions fixing. Although the index dropped the automobile and parts sector dropped more!
- Armchair Academy: Introduction to Equity Sector Futures
- Navigating market reversals and key risk events
- Sentiment sours as US exceptionalism looks more fragile
- Trump’s reciprocal tariffs and their global implications
Investors can use both the indices and sectors, depending on the balance of their stock portfolio. It is expensive to keep buying and selling stocks each time the market turns, or at least looks as though it might. Using indices and sectors is a cheaper solution as you can hold the stocks and hedges by selling the index or sectors closely matching your portfolio. Simply holding on to the stocks will impact your capital, at least in the short term.
Trading/investing is not about following others but developing your own knowledge of the markets and creating a trading/investment plan that includes a solid strategy that will perform consistently over time. Being able to adapt to various market conditions and understanding the key drivers of a market can provide incredible opportunities.
