It’s no secret that stock market indicators can help you judge the performance of your investments. The problem is that there are hundreds of indicators to choose from, including well-known ones such as the New York Stock Exchange Index, the Standard & Poor’s Index and the Value Line Index.
How do you know which indicator you should be following? The answer to that question depends on what type of investor you are.
Before you can determine which market indicator is best suited to your needs, you first need to understand just how they work. An investment index reports the performance of a segment of the market and helps determine how an investment is performing in relation to that market segment.
Analysts use indexes to measure the ups and downs of stock, bond and commodities markets. Each index is made up of a list of specific stocks and reflects market prices and the number of shares outstanding for the companies in the index. For example, the S&P 500 Index measures the overall change in the value of the stocks of the 500 largest firms in the U.S.
Some mutual funds are based on indexes, meaning the funds buy stock from the indexed list of companies. But investors can also buy index options. Options are contracts that give you the right to buy or sell 100 shares of a specific stock at a set “strike price” within a certain period. It is cheaper to buy an option than to buy shares of each company on the index, so investors save money by betting on whether shares in a certain group of companies will go up or down in price.
Here are five indexes across various market sectors that are worth checking out:
1. TRIN (Arms Index)
This is the index to watch if you’re into short-term trading. The “Trin,” which stands for the “Trading Index,” measures investor sentiment through a formula that considers the number of stocks that are increasing in value (advancing stocks), the number declining in value (declining stocks), and whether the number of shares of all stocks being traded is rising or falling (advancing or declining volume).
You read the index by looking at the resulting number. A reading of 1.0 means the market is stable. More than 1.0 suggests a weak market ahead. Less than 1.0 indicates a strong market.
2. XAU (Gold and Silver Index)
The XAU is composed of the common stocks of 16 companies involved in the gold and silver mining industry. People pay more attention to gold and silver prices whenever inflation starts to rise.
There is basically a positive correlation between the price of precious metals and inflation. This means that in an environment where you have rising inflation, you should see the prices of precious metals moving up.
3. WSX (Wilshire Small-Cap Index)
The WSX is a stock-performance measurement index comprised of 1,750 companies within the small-cap sector. To tell whether a company is a small cap, multiply the price of its shares by the number of shares on the market. If the result is between 50 million and 500 million, the company qualifies as a small cap.
The WSX index is mainly useful for people who trade derivatives related to the small-cap segment. Derivatives are contracts whose value is based on the performance of an underlying index or other investment.
Small-cap stocks tend to be more volatile, but they also carry a chance for larger returns than large-cap or mid-cap stocks. A small-cap investor can lessen his risk by watching and buying the WSX index options.
The small-cap index is intended to give you a very good measure of how the smaller companies are performing, and a much better measure than any index that would incorporate both large and small companies.
4. BKX (KBW Banking Index)
The BKX index lists 24 of the country’s largest banking and brokerage institutions. Follow the BKX and you will know who the biggest banks are and how they’re performing. Index members include Bank of America, Citigroup and JP Morgan Chase.
5. VIX (CBOE Volatility Index)
The VIX, also known as the “Fear Gauge,” is one of the most widely accepted methods to gauge market volatility. This index should skyrocket whenever the next stock market crash happens. Using short-term, near-the-money call and put options, the index measures the implied volatility of S&P 500 Index options over the next 30-day period. After the 2008 crash, this investment was 2,400% higher than it is now.
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