Index Trading: 4 Things You Should Know About The S&P 500
The S&P 500 or the Standard & Poor’s 500 Index was established in 1957. It was launched when the two companies, Standard Statistical Bureau and Poor’s Publishing, merged. The index was created to keep track of the 500 companies’ value and the possibility of getting listed on the Nasdaq and NYSE.
Today, S&P 500 is one of the well-known indices. Investors usually look at this index to determine whether the market is doing well or not. So if you’re interested in trading indices, it’s best if you get to know the most popular, like the S&P 500.
If you’re interested in this index, below are the things you should know before you start trading!
1. It uses the market-cap weighting method, and stocks don’t equally affect the index
Market capitalisation represents the value of a company. It’s computed based on the current market price of shares multiplied by the total number of outstanding shares. Since each component of the S&P 500 has a represented value, it’s easier to determine the current state of the index.
As for the market cap of the entire S&P 500, it’s calculated by adding the market cap of all the companies under it.
Since the S&P 500 uses the market-cap weighting method, companies with higher valuations also have higher percent allocation.
Unfortunately, the problem with using this method is when a company or stock with a high percent allocation becomes overvalued, it can also inflate the whole value of the index. This is also one of the reasons why equally weighted indices are becoming popular.
Fortunately, there’s no need for investors to compute the market cap of each company and the total market cap of the S&P 500 because it’s usually posted online.
2. It’s not exactly comprised of the 500 largest US companies
It’s not the top 500 largest companies, but 500 of the largest companies in the US. As mentioned, S&P 500 uses the market-cap weighting method, so the first qualification to be included in the S&P 500 is a market cap of at least $14.6 billion.
Aside from that, below are other well-known qualifications to be included:
- Based on and publicly trading in the US
- Has positive earnings
- Doesn’t have more than one class of common stocks
- At least 10% of its shares are publicly traded
- The total price of the stock must be higher than the publicly traded, a year before joining the index
Meanwhile, there are currently 505 stocks in the S&P 500 Index under 500 of the largest companies in the US.
3. Companies under S&P 500 change over time
As mentioned, S&P 500 was introduced in 1957. And according to experts, the companies included in the index in 1965 lasted an average of 33 years. Less than 100 of the original S&P 500 companies remain in the index.
Since the criteria are a bit strict, there’s no doubt why companies come and go in the said index. So if a company didn’t do well as before, there’s a chance that you won’t be able to see them in the list of stock in the S&P 500.
One example is the case of the United States Steel Corporation. There was a time when the company was known for being the largest in the world. Unfortunately, in recent years, they didn’t gain any profit, so the index had to let them go.
4. S&P 500 is a bit diverse
As of February 2023, the S&P 500 Index is comprised of the following sectors:
- Communication Services
- Consumer Discretionary
- Consumer Staples
- Health Care
- Real Estate
As a beginner, trading S&P 500 index is good enough to get your portfolio started. Besides, if you’ll look at the list of sectors above, it’s a better trade than selecting a few stocks and investing in them.
However, if you’re a mid to pro trader, investing in S&P 500 index alone can’t give you a better portfolio. As you can see, it’s not as diverse as you think.
How Do You Invest in the S&P 500?
Similar to other indices, you can invest in the S&P 500 by buying shares from index funds. In addition, you can also buy shares from companies under the S&P 500. The latter is popular among investors, especially when they’re confident about the performance of the index.
On the other hand, investing in index funds is also a great idea since it mimics and closely monitors the performance of the said index.
Unfortunately, it’s impossible to invest directly in the index. Which is why the other ways mentioned above were created.
Should you invest?
If you’re looking for different indices to trade, looking into S&P 500 is great. However, you should also consider the others, as the one you choose reflects your trading style and strategy.
Overall, if you’re planning to trade indices, try to get to know them well first before deciding.
We hope the information we’ve provided helps you get to know the S&P 500 well. If you have concerns, questions, or suggestions, don’t hesitate to leave a comment below!