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What is a Market Index? A market index could be defined as a representation of a security market, market segment, or asset class of freely tradable market instruments. A market index is primarily made up of constituent marketable securities and is re-calculated on a daily basis. There are basically two forms or variations of the same market index, i.e., one version based upon the price return known as a price return index, and one version based upon total return know as a total return index. Why Do We Need A market Index? Ideally, a large number of market participants including investors and institutional funds gather and analyse vast amounts of information about security markets; however, doing so could be a very troublesome and tiring task as the work is both time consuming and data-intensive. Thus, a large number of market participants prefer to use a single measure that could represent and consolidate a plethora of information while reflecting the performance of an entire security market of interest. This is where market indexes play a major role as they are often a simple measure to reflect the performance of any underlying market of interest. For example, S&P500, NASDAQ, are believed to reflect the true performance and picture of the U.S. stock market in particular and U.S. economy in general. Likewise, many indexes such as S&P/ASX 200 is believed to reflect the performance of the Australian stock market and so on. Index Construction Constructing a market index is almost similar to constructing a portfolio of securities as the construction of an index requires: Target Market and Security Selection The first and the primary decision in constructing an index is to identify the target market and select financial instruments which reflect the true nature of the underlying market. The target market, which determines the investment universe and securities available for inclusion, could be based on any asset class, i.e., equities, fixed income, commodities, real estates or on any geographic region. Once the target market is identified, the next step is to select securities which represent the true nature of the target market and decide on the number of securities to be included in the index. Ideally, a market index could be of all securities in the target market or a representative sample of the target market. For example, some indexes such as FTSE 100, S&P 500, S&P/ASX 200, fix the number of stocks to be included in the index while indexes like Tokyo Stock Price Index (or TOPIX) select and represents all of the largest stocks, known as the First Selection. For such indexes, the included securities must meet some basic parameters like pre-decided market capitalisation, the number of shares outstanding, to remain in the index. Weight Allocation The weight allocation varies considerably among indexes depending upon the method of weight allocation, and it basically decides on how much weight each security in an index carry. The method of weight allocation is one of the most important parts that investors need to understand thoroughly as it has a substantial impact on the value of an index. Some of the most widely-used weight allocation methods are as below: Price Weighting This method was originally used by Charles Dow to construct the Dow Jones Industrial Average (or DJIA) and is one of the simplest methods. The price weight method determines the weight of each individual security of an index by dividing the price of the security by the sum of prices of all securities. In simple terms, each security gets the weight of its price in proportional to the total price of the index. The primary advantage of this method is its simplicity; however, the method leads to arbitrary weights for each security as the method is highly sensitive to some market actions such as stock split. Equal Weighting As the name suggests, this method assigns equal weight to all securities in an index. Just like equal weighting, the major advantage of this method is its simplicity; however, this method tends to underrepresent the value of large securities and overrepresent the value of smaller securities. Market-Capitalisation Weighting Market-Capitalisation method weight each constituent by dividing its market capitalisation with the total market capitalisation of the index, i.e., the sum of the market capitalisation of each constituent. The market capitalisation could be determined by multiplying the number of outstanding shares of the security with its market price per share. Rebalancing and Reconstitution Rebalancing of a market index could be defined as the adjustment to the weights of the constituent securities. Depending upon the method of weighting an index, the weight of each individual security tends to change due to market actions or price appreciation and deprecation, in similar fashion to a stock portfolio requires scheduled rebalancing. A majority of market indexes are rebalanced on a daily basis as price tends to often change regularly. On the other hand, reconstitution could be ideally defined as the process to change the constituent of a market index. As suggested above, many market indexes such as TOPIX require each constituent security to meet some parameters for the inclusion; however, due to market dynamics, various securities tend to get added or removed from an index time to time. Uses of Market Index Originally, market indexes were created to provide a sense to investors on how a security market performed on a given day. However, with the development of the modern finance theory and growing numbers of indexes in the market, uses of market indexes have been expanded significantly. Some of the major uses of market indexes are as below: To Gauge the market sentiment A market index is usually a collection of the opinion of market participants; thus, they reflect the attitude and behaviour of the market participants, making them one of most widely used tool to gauge the market sentiment. To measure and model the risk and return profile of a market Market indexes could serve as a proxy for systematic risk in many popular models such as the Capital Asset Pricing Model (or CAPM). The market portfolio, which represents the systematic risk of the market often uses a market index, as a proxy of the market portfolio as including the whole population or all stocks in the model could lead to wrong output, and it could be very costly and cost consuming. Serves as a Performance Benchmark Market indexes often serve as a performance benchmark for individual investors and especially large investors such as mutual funds, ETFs, pension funds, and large banks.
What is Nasdaq? Nasdaq Stock Market is a global electronic marketplace for buying and selling securities on an automatic, transparent and speedy electronic network. It trades through a computer system rather than in a physical trading floor for the traders to trade directly between them. It is an American stock exchange located in the Financial District of Lower Manhattan in New York City. NASDAQ is owned by the company Nasdaq. Inc. and ranked second on the list of stock exchanges as per market capitalisation of shares traded. The first rank goes to the New York Stock Exchange. Nasdaq-National Association of Securities Dealers Automated Quotations, was founded in 1971 by the National Association of Securities Dealers (NASD) to avoid inefficient trading and delays. Nasdaq. Inc. company also owns the Nasdaq Nordic stock market network in addition to other exchanges. The exchange has more than 3,100 companies listed. They are the highest trade volume companies in the US market, valued more than US$14 trillion in total. Good read: NASDAQ surged up above 10,000 – Tech stocks setting a new benchmark What is Nasdaq known for? Nasdaq currently is the largest electronic stock market, and it is most well-known for its high-tech stocks. But it also has a variety of companies listed such as capital goods, healthcare, consumer durables and nondurables, energy, public utilities, finance and transportation. Nasdaq boasts of having some of the largest blue-chip companies in the world and attracts high growth-oriented companies. Its stocks are known to be volatile than those listed on other exchanges. Apart from listed stocks, Nasdaq also trades in over the counter (OTC) stocks. The ticker symbols for the listed companies’ stocks on the Nasdaq have four or five letters. The Nasdaq Composite index was initially termed as Nasdaq. It included all the stocks listed on Nasdaq stock market and also many stocks listed on Dow Jones Industrial Average and S&P 500 Index. The index has more than 3,000 stocks listed on it which include the world’s largest technology and biotech giants like Microsoft, Apple, Amazon, Alphabet, Facebook, Gilead Sciences, Tesla and Intel. Did you read: Blue-chip stocks: Value versus Growth in Covid-19 Era Companies have to meet certain criteria to get listed on the NASDAQ National Market. The entities have to meet financial, liquidity, and corporate governance-related requirements. Have to get registered with the Securities Exchange Commission (SEC) Have to maintain the stock price of at least US$1. Company’s value of outstanding stocks must total at least US$1.1 million. The small companies which cannot meet the criteria can get listed on NASDAQ Small Caps Market. Nasdaq changes the companies as the eligibility of the companies keeps changing. Image: Kalkine What are different Nasdaq indexes? Nasdaq uses an index to list its stocks like any other stock exchange. The index delivers stock performance snapshots. The New York Stock Exchange (NYSE) has the Dow Jones Industrial Average (DJIA) as its primary index; it tracks the stock price of 30 big companies. Nasdaq Composite and the Nasdaq 100 are two indices of Nasdaq. Nasdaq Composite measures the performance of more than 3,100 listed companies’ stocks trading daily on Nasdaq. Nasdaq 100 is a modified capitalisation-weighted index. This index has listed companies from various sectors, but the majority is from the technology industry. Depending on their market value, Nasdaq adds or removes the companies from its index Nasdaq 100. Both the NASDAQ Composite and the NASDAQ 100 indexes have listed companies from the United States as well as global companies. On the other hand, Dow Jones Industrial Average index does not include companies outside of the US. Did you read: Hanging Up Your Boots? Investment Strategies to Help you Relax and Build Wealth Brief history Nasdaq performance in the past has been groundbreaking and extraordinary. One of its highly regarded accomplishments is that Nasdaq was the first-ever stock exchange for offering electronic trading. It was the first to launch a website and stored all the records in the cloud. Interestingly, Nasdaq also sold its technology to other stock exchanges. Nasdaq invented the modern Initial Public Offering (IPO) as it listed venture-capital-backed companies. Initially, it merged with the American Stock Exchange. It formed the Nasdaq-AMEX Market Group, later on, the AMEX index was acquired by NYSE Euronext, and the entire data was integrated into NYSE. In 2007 Nasdaq acquired OMX which is a Swedish-Finnish financial company. Followed by which Nasdaq changed its name to NASDAQ OMX Group. NASDAQ OMX Group bought the Boston Stock Exchange and also the Philadelphia Stock Exchange which was the oldest stock exchange in the US. Also read: Nasdaq index’s Tech Titans kicks off with Bold Performances How to trade on Nasdaq? Though the New York Stock Exchange is the largest exchange by market capitalisation, Nasdaq is the largest by trading volume due to its electronic quote mechanism. Nasdaq is a dealer’s market where the public buys and sells stocks with the help of the market maker (a registered broker/dealer). The market maker provides the buy and sell quotes and takes the position in those stocks. NYSE works differently as the buyers and sellers can trade directly with each other, and a specialist allows the trade. On Nasdaq, the market maker owns inventory and trade stocks in his/her capacity. Good read: Why NASDAQ Composite index plunged 5%?
In 2013, the television host of CNBC's Mad Money, Mr Jim Cramer addressed few stocks as “totally dominant in their markets”. He was referring to tech titans and named them FAANG stocks (where the extra “A” was added 5 years later, in 2017). ALSO READ: Investment in Technology Stocks - A Beginner's Guide What Are FAANG Stocks? “FAANG” is perhaps one of the most popular abbreviation of the business world. The acronym illustrates stocks of the famous five US-based technology corporations- first being social media giant Facebook Inc., followed by software and hardware developer Apple Inc., the e-commerce magnate Amazon.com Inc., and the streaming service provider Netflix Inc., along with the last FAANG member, internet ace Alphabet Inc. (formerly recognised as Google). Originally, the acronym was FANG (with an “A” for Amazon.). In 2017, investors included Apple in the group, turning the acronym into FAANG. There is an interesting fact here- The original four FANG stocks were pure internet-based companies, but the later inclusion of Apple, that is a consumer hardware manufacturer, made FAANG stocks a broader group of giant technology stocks. Widely renowned among consumers, unique in their products and services, these stocks are of few of the largest companies in the world. They trade on the NASDAQ Exchange and are included in the S&P 500 Index, making up approximately 15 per cent of the index. Market experts believe that since these stocks have a large influence on the index, they tend to have a substantial effect on the performance of the S&P 500, in general. GOOD READ: FAANGs Defining Resilience Amid Market Downtrends Why Are FAANG Stocks Popular? FAANG companies exhibit several competitive advantages that make them attractive long-term investments. Consider this- Facebook rules social networking, Amazon is the one-stop destination to buy goods online in today’s digital world; Apple’s iPhones are one of the most used and well-renowned gadgets globally; Netflix is considered to be a leader of online streaming; whereas Google is the search engine used comprehensively almost every day, everywhere. These disruptive companies benefit from what is known as the network effect (indirect value goods and services gain as more people use them). Facebook’s products are valuable to new users because of its vast other active users. Amazon’s Prime service brings millions of shoppers to its marketplace every day, making its seller services more attractive to third-party merchants. Millions of Netflix viewers provide feedback for the kind of content the company should invest in. Lock-in effect of the Apple ecosystem creates substantial switching costs for iOS users. FAANG companies have intangible assets. This opens doors to the possibility of producing higher levels of profitability than rival companies. Consider this- Facebook, Amazon, and Google have troves of user data to pursue advertisements. Netflix offers original content, exclusive licenses that make its content library unique. Apple, on the other hand, is one of the few technology companies that makes hardware as well as software for its devices. FAANG players contribute to radical lifestyle change. One obvious reason for the popularity of these market darlings is that each FAANG company has been known to transform not just their own industries and the markets, but also how we all live in the current contemporary lifestyles. What is the significance of FAANG Constituents? As the heavy weighting of FAANG stocks in indexes like the S&P 500 gives them an outsized impact on the broader stock market, it seems worthwhile for investors to learn a bit about them. How is Investing Community Exposed to FAANG Stocks? FAANG stocks have historically outperformed the S&P 500 index. Over the last decade, this famous group accounted for a large portion of the market’s gains and American economy growth. This seems obvious given that FAANG companies have a hoard of competitive advantages making them seem like lucrative long-term investments. Offering perhaps the hottest technology trends, FAANG stocks demonstrate strong sales and earnings growth. Each FAANG company is listed on the NASDAQ, so purchasing their shares is a straightforward process for most investors. The easiest path could possibly be via online brokerage account with companies that offer this service. At this point, it should be noted that FAANG stocks aren’t cheap. For instance, for most of 2019, one share of Google sold for well over USD 1,000 and Amazon traded above USD 1,500. However, a wise investor knows that past results do not guarantee future success. Sinusoidal equity market trends deserve closer attention to a lot of other aspects before making any investment decision. Therefore, investing in FAANG stocks should be vigilantly based on one’s research of fundamental and technical aspects and risk appetite. GOOD READ: Investing Tips: 4 Reasons Big Techs can always stay your best pal Are There Any Risks Associated to Investing in FAANG Stocks? Market experts believe that there are no sure plays in the investing world. Simply put, there is a risk in every aspect of investing. Though favourable market conditions and investor enthusiasm for technology seems to be here for good, global uncertainties always should be considered. Overly bullish expectations coupled with certain political pressures and economic worries may hinder these big techs’ growth. Some experts opine that as these companies continue to mature amid mounting worldwide risks, it may get increasingly difficult for them to maintain their rapid growth pace. Legal Regulatory, market and operational risks of these FAANG players need to be considered before taking any exposure to FAANG stocks. Amazon and Google have often come under regulatory examination for potential anti-competitive business practices. Facebook and Google have faced criticism for lack of data privacy and security. On the other hand, Netflix has encountered new competitors in streaming video and as few reports suggest, a huge debt load linked with content production. Valuations of FAANG players should be well justified viz-a-viz earnings guidance of these players, before taking any investment exposure. Are There Global Peers to FAANG Stocks? Just like FAANG stocks, there are several groups of companies that can be looked upon as peers to the tech group. Let us cast an eye on similar groups- The Australian variant, WAAAX stocks comprises WiseTech Global Limited (ASX:WTC), Appen Limited (ASX:APX), Altium Limited (ASX:ALU), Afterpay Limited (ASX:APT) and Xero Limited (ASX:XRO). GAFAM is an acronym for the five most popular US. tech stocks: Google, Apple, Facebook, Amazon, and Microsoft. BATX is the abbreviation for the four popular technology stocks from China: Baidu, Alibaba, Tencent and Xiaomi. TAND, which comprise of Tesla, Activision, Nvidia and Disney are often looked up as future giants of tech. TANJ stocks in Hong Kong comprise Tencent, Alibaba, NetEase and JD.com. The Canadian big tech club DOCKS constitutes Descartes Systems, Open Text, Constellation Software, Kinaxis and Shopify. Do You Know These Interesting Facts About FAANG Stocks? The FAANG group has been a stock market superstar on both short and long-term basis. These stocks have more or less consistently delivered above-average sales and profit growth and maintained juicy margins. Let us look at a few interesting facts about these tech titans- In August 2018, FAANG stocks were responsible for nearly 40 per cent of the S&P 500’s gain from the lows reached in February 2018. Over the past decade, FAANG stocks have grown faster than the overall S&P 500 or the more technology-focused NASDAQ. There is no exchange traded fund dedicated solely to FAANG stocks. Since the market bottom in March of 2009, the worst performing FAANG stock, Apple, has returned over double that of the index average. Amid the COVID-19 market downturn FAANG companies were one of the biggest beneficiaries as the “stay-at-home” economy led to an acceleration in their trajectories as people’s lives shifted online. Rather than resting on their achievements and dominant market position, FAANG companies choose to use their cash on hand to make investments in cloud computing, AI and other technologies that they believe may lead to continued revenue growth.
Falling Knife A falling knife is a colloquial term which is often used in the financial market. The term is specifically used when the price of the security falls quite rapidly or sometimes also referred to when the price keeps falling for quite some time. The term often comes across as “Don’t try to catch a falling knife” or “trying to catch a falling knife is very risky”. Why is a falling knife so risky? The price moves every second throughout the trading window and keeps doing so every next trading session. Therefore, price is always said to be in motion, it could either be an upward or downward movement. When the price falls with very high velocity like what the world witnessed during the initial phase of Coronavirus pandemic, then this specific movement or price is said to be a falling knife. This downward momentum is so strong that there is virtually no level where the price stabilizes until the fall is not ended. Every support level, major or minor gets hammered, and during the fall, no enthusiasm is seen from the buyers. Therefore, the sellers keep on selling the security even at lower prices, without enough buyers to absorb the entire supply. Hence the downward movement is on till the sellers feel that the market has reached an oversold price level and stop selling further. This is when the fresh enthusiasm of buyers comes in, and prices start to move up. What does it mean to “Catch a falling knife.” During the course of severe correction in the market, it is tough to predict or estimate some support areas where the supply may end, and the price may halt. Trying to catch a falling knife means taking a very high risk and trying to buy the security at current levels in anticipation that the price would reverse from here. In the normal conditions, generally more accurate estimates can be made as to from where the price may reverse but understanding the correct price at which one should buy in the case of a severe downtrend is not so easy. Therefore, if the timing goes wrong while buying the security, then the trader may not even get a chance to get out around the same price. This situation is exactly like trying to catch a falling knife in the real scenario as in, if the knife keeps on falling after the intervention by your hand in an attempt to stop it, then it would probably cut through your hands. What are the reasons for the occurrence of a falling knife? The falling knife is a dangerous downward move which is accompanied by huge volume. That means mass participation generally takes place during these kinds of moves as moving prices with such a very high momentum cannot be a one-man show, especially in a liquid market like ASX200 or Dow Jones. Image Source: ©Kalkine Group 2020 There could be many reasons which may instil a sense of excessive fear amongst the market participants, which ultimately triggers these moves. Here are a few examples of such reasons Earnings Report Every quarter the listed companies declare their earnings report to the public. Every investor of the company has his own expectations with respect to the company’s performance. But not always, the company meets the investor’s expectation and sometimes leads to disappointment. If the company’s performance is totally not acceptable by the investors, then it may also trigger excessive selling of shares which may last for a few weeks. Global Threat The most recent example of a global threat is Coronavirus pandemic. In the initial phase of the pandemic, during Feb and March 2020, the markets across the globe were depicting the exact movement of a falling knife. The fall was so intense that the only mechanism that was stopping the markets from falling further were the lower circuits. Other global threat or emergencies like a terrorist attack, severe natural calamity etc. may also be the reasons for such aggressive downfall. Technical Breakdown Technical breakdown refers to a break of a significant support level on the price chart. Sometimes a major technical breakdown is enough to trigger a ferocious selling. This happens mostly after the break of long-term support or a firm support level. These technical levels often provide a warning well before the breakdown, although may not always be correct, a trader can definitely become cautious after the breach of these levels. How to profit from a falling knife? The ideal trade to place during a falling knife is to go short on the security and follow the trend. Trend following approach may help even better if the trader could enter around the beginning of the move and ride the trend all the way to the bottom. However, there is never the “only way” in the market, and there is another bunch of traders/investors who think the opposite and try to buy during the fall. This is called a mean-reversion approach because it is expected that if the price falls too much too quickly, then it tends to deviate from its mean price. These investors bet on the assumption the price would soon revert back to its mean by giving an opposite move. Bottomline A falling knife is a ferocious down move which is difficult to trade for both the short or long position. Traders need to have quite an accurate timing of their trades. If timing the move is done correctly, then a trader can make money both ways else it isn't easy. For the new traders with less experience, it is generally recommended to sit aside till the calm sets in.