How markets work · Lesson 2 of 8

Stocks, ETFs and indexes

When people say "the market was up today", they usually mean a stock index went up. This lesson explains the three building blocks behind that sentence: individual stocks, the indexes that summarise them, and the funds that let you own a whole index in one trade.

Stocks

A stock (or share) is a unit of ownership in a company. If a company has issued 100 million shares and you own 100, you own one millionth of it. Shareholders usually get a vote on certain company matters and a claim on profits, which some companies pay out as dividends, regular cash payments per share. Others reinvest profits instead.

A share's price reflects what buyers and sellers think the company's future cash flows are worth today. It moves with company news such as quarterly earnings, with the economy, with interest rates and with general mood. Shares of public companies trade on exchanges. Regular trading hours on the main US exchanges are 9:30 a.m. to 4:00 p.m. ET on weekdays, with extended sessions before and after, where fewer orders are waiting and spreads are usually wider.

Indexes

An index is a single number calculated from the prices of a group of stocks, built to show how that group is doing as a whole. You can't buy an index directly. It is a measurement, like a temperature reading.

Three US indexes come up constantly:

• The S&P 500, maintained by S&P Dow Jones Indices, tracks about 500 large US companies. It is market-capitalisation weighted. Market capitalisation is a company's share price multiplied by its number of shares; the S&P 500 counts only the shares available to the public. Larger companies move the index more than smaller ones.
• The Nasdaq-100 tracks 100 of the largest non-financial companies listed on the Nasdaq exchange. It is also weighted by company size, with rules that cap the largest weights. Because it holds many large technology companies and no banks, its moves can differ noticeably from the S&P 500's.
• The Dow Jones Industrial Average tracks 30 large US companies and is price weighted: a stock with a higher share price has more influence, regardless of the company's overall size.

Every country with a stock market has its own indexes, such as the FTSE 100 in the UK, the DAX in Germany and the Nikkei 225 in Japan. The ideas in this lesson apply to all of them.

What an index point is

An index level is just a number, and a point is one unit of that number. If the S&P 500 moves from 5,000 to 5,050, it has risen 50 points.

Points on their own don't tell you much, because the same number of points is a different percentage at different levels. Suppose one index is at 5,000 and another is at 20,000. A 100-point rise is 2% for the first and 0.5% for the second. That's why a large point move in an index with a high level can be an ordinary day. When comparing moves, look at the percentage change.

Points do matter directly when you trade products linked to an index, such as futures, where each point is worth a fixed amount of money. Lesson 5 covers that.

ETFs

An exchange-traded fund (ETF) is a fund that holds a basket of assets and whose own shares trade on an exchange like a stock. An S&P 500 ETF, for example, holds the stocks in the index in roughly the same proportions, so its price follows the index closely. Buying one share of the ETF gives you a small slice of all of them.

A few things to understand about ETFs:

• Costs. Every ETF charges an annual fee called the expense ratio, taken out of the fund's assets. It is published in the fund's documents.
• Tracking. An index ETF's return won't match the index exactly, because of fees and the practical details of holding the stocks.
• Not all ETFs are simple. Some use derivatives to deliver two or three times the daily move of an index, or the opposite of it. These leveraged and inverse ETFs reset daily, so over longer periods their returns can differ a lot from a simple multiple of the index. Their documents usually say they are designed for short holding periods.

Why indexes matter even if you trade single stocks

Many stocks tend to rise and fall together with the broad market, especially on big news days. A trader who is long one stock is often, in part, making a bet on the whole index. Knowing what the index is doing, and why, helps you tell a company-specific move from a market-wide one.

Where to see them on PYE Markets

The Markets page shows major indexes alongside their volatility gauges, each with its source and time. The Earnings page lists company reports, which are among the most common reasons a single stock moves sharply.

Key terms

Stock (share)

A unit of ownership in a company.

Index

A calculated number that summarises the prices of a group of securities; it cannot be bought directly.

Market capitalisation

Share price multiplied by the number of shares; a measure of company size.

Index point

One unit of an index level. Compare moves in percent, not points.

ETF

A fund whose shares trade on an exchange, often built to track an index.

Expense ratio

The annual fee an ETF or fund charges, as a percentage of assets.

Next lesson: Lesson 3: Bonds and interest rates

General education, not investment advice.