People that access the capital markets, be it the equity, the commodities or the forex, often come across the various indices. The index is nothing but a statistical measure of the functioning of the markets. They seek to establish a balance to the very functioning of the system by acting as a convenient benchmark to which performances can be calibrated against. Thus for all practical purposes, the indices are a window to the full functioning system than anything else.
The best way to consider the typical index is to see it as a weighted measure of the market. By being weighted, it is meant to tell out that the different constituents of the index are not in the same measure but their influence differs in a pre-determined ratio. So the underlying that influences or marks out the actual happening the most would get to have the highest weightage on the index. The aim would be to bring in a true barometer of the system under consideration.
So as a corollary, the stock index would have the stocks on offer on the exchanges as the underlying and if it is the commodity index, then it would be the commodity rates that decide how the indices should behave. In the actual world it is possible to find certain indices that try to measure the volatility of the system and they would be typically an index made from the major indices.
Although a typical market index would be constituted from the prevailing prices of a handful of the underlying products, it would be a good measure of the happenings of the market. This is the main reason that people tend to put the index to work in minimizing risks and controlling the potential for making loses.
When the markets are on a strong upward trend, this is bound to be reflected in the way the indices behave. It would then be possible to keep watch levels of the index and to control the exposure of the investor to the market. More often what is seen is that, there are sector indices that point to systemic imbalances and this would be just the opportune time to take money out of the over performing sectors.
Most markets are exposed to the use of the derivatives in the everyday functioning. The index does play a strong role in deciding whether to invest in a particular derivative or not. In brief the indices can be put to good use to control the amount of risk that a investor or even the speculator is exposed to at any one point of time.
The index to a market is a derivative instrument. That is, on its own, the index is worthless. But the value of the index is derived from some underlying product, which could be the share or commodity price or even the forex rates at a particular time. Thus the index does change in value as the value of the underlying product changes and if the product can be traded on the market, then why not the index as well.
It is this premise that has given rise to the trade in the market index. Quite unlike trading in the spot market, the use of index would tend to be less volatile and even be less of a risky venture. A well constructed index would be a true and complete measure of the system than a particular statement on the individual stock or commodity.
The typical capital market would have its share of pulls and pushes. One of the strong points to using the index is its ability to have a complete picture after balancing out the various pulls and pushes. This is the prime reason that a lot of the index trades take place as the scope for its appreciation over the long term time frame is understood.
No matter the market segment that is considered, there is bound to be a number of operators that can be termed as speculators in the market. These folks tend to be looking for opportunities for a quick return on sum invested. This happens mainly due to the imperfections in the system that creates difference in the buys and sells rates. Thus for all practical considerations, the speculators would appear at any active market; be it the equity market, the commodity market or the forex markets.
It is possible to keep out the risks to the investments from speculation activities by effectively using the indices. Since for the most parts the index levels point to a scenario where the speculator activity is minimal it would be just the right place for the safe investor who is seeking safety to the invested amounts. The fact that the true value of the index would always be so high that it would not be possible to influence it under normal operating conditions would make it stable too.
In practice, the index is just another tradable product on the capital markets. The typical market value of the index would often be the most marketable part to the index too. There would be little need to argue with a force that tends to have a mind of its own and this in the true sense is the beauty of the index most of the time.
A strong market would be just the place to locate a strong set of indices. This is the prime reason that most market regulators seek to establish a strong set of indices and something that cannot be influenced by the normal market forces.