INDICES VS. EXCHANGES
INDICES VS. EXCHANGES
By now, you’ve heard the terms “index” and “exchange” quite a bit, but what are they really? Here’s a quick look at the major differences between the two.
An Index is a statistical measure of change in a securities market. In other words, an index in the financial markets is an imaginary portfolio of different stocks designed to represent a particular market (such as the technology sector) or a part of it. Each index has a different methodology when it comes to calculation and it is usually expressed in terms of a change from a base value. As such, looking at the percentage change is more valuable than just the numeric value. The Standard and Poor’s 500 and the Dow Jones Industrial Average are the best-known indices and are often used as a benchmark for the stock market because they include a wide range of companies that best represent movements in the overall market. However, there are a wide variety of indices that people can use to track the performance of sectors or country-specific stocks, depending on their investing style or objectives.
Essentially, an index is used for comparison purposes and lets you evaluate the performance of your portfolio versus how the market is doing in general. For example, if your portfolio contains mostly technology stocks, a good index to track your performance against would be the NASDAQ, where most technology stocks lie.
That being said, you can’t actually invest in an index, however, there are mutual funds and exchange-traded funds that are based on indices that allow investors to invest in stocks that represent vast market segments or the total market depending on your preference. This is what is known as passive investing, where an investor is accepting market returns instead of trying to perform better than the market by trying to select higher performing stocks through active investing. Typically, even professional mutual fund managers find it hard to outperform their market index regularly year after year, so less experienced investors may find it in their best interest to invest more passively.
An exchange is a marketplace, either physical or electronic, where financial products such as securities and commodities are bought and sold. The main goal of an exchange is to ensure fair, organized trading as well as efficient dissemination of price information for the securities on that exchange. An exchange may also be referred to as a “share exchange” or a “bourse” depending on the location. The New York Stock Exchange and the NASDAQ are both exchanges.