What drives stock index ?

[secondary]

zz

 

[Glenn]

Hello,

I understand the index is a composite of range of stocks. Then when people bet on the index itself does the exchange invest in all stocks to drive the whole market ? or are people just "betting" on the direction, in which case what is the economic merit of this ?

Thanks

What drives the Index is the net effect of the traded price changes to all the stocks it contains.
You have an index of a number of stocks, and the index price is made up from the prices of those stocks. If the stock prices go down, the index value goes down, and vice versa.

You can't bet on the index itself, you can only bet on a derivative of it.
i.e. Futures, Options, Exchange Traded Funds, Spreadbet price, Bookmaker odds.
Unless that is, you yourself buy or sell a proportionate sample of all the constituents of the index (which is akin to an exchange traded fund).

So you can only bet on the direction of the Index using these derivatives.

The Exchange does what it's name suggests - it exchanges orders. You buy from a market maker and sell to a market maker, electronic or human, via the exchange.

The economic merit ?..... to whom ?
The exchange levies a charge to you for your data feed if you have one.
The Market maker sets the bid/offer spread and makes his money from that.
The broker charges commission per trade.
So you start every trade at a loss because of the above charges, and hope that your eventual profit will pay for them, and more.

Glenn

 

[Windowsill]

What drives the Index is the net effect of the traded price changes to all the stocks it contains.
You have an index of a number of stocks, and the index price is made up from the prices of those stocks. If the stock prices go down, the index value goes down, and vice versa.

You can't bet on the index itself, you can only bet on a derivative of it.
i.e. Futures, Options, Exchange Traded Funds, Spreadbet price, Bookmaker odds.
Unless that is, you yourself buy or sell a proportionate sample of all the constituents of the index (which is akin to an exchange traded fund).

So you can only bet on the direction of the Index using these derivatives.

The Exchange does what it's name suggests - it exchanges orders. You buy from a market maker and sell to a market maker, electronic or human, via the exchange.

The economic merit ?..... to whom ?
The exchange levies a charge to you for your data feed if you have one.
The Market maker sets the bid/offer spread and makes his money from that.
The broker charges commission per trade.
So you start every trade at a loss because of the above charges, and hope that your eventual profit will pay for them, and more.

Glenn

How do the Spreadbetting companies balance the books? ..... I've often wondered about this!

 

[Mornington Crescent]

You are using the word 'bet' , largely I suspect because you do not understand the markets properly.

The market exists primarily for institutions. Ignore the retail investor, he is playing a less significant role in the markets and has been doing so for many years.

Both Options and Futures allow institutions to protect the value of their portfolios AND provide liquidity so that prices are generally kept within reasonable bounds even during a 'fast market'

It is questionable how good most institutions are at doing this but that is a different matter

 

[tomorton]

Hi secondary - there is no clear direct economic benefit from trades based on the exchange indices to the exchange participants (member companies, such as those firms in the FTSE100). But there is a huge benefit to those firms that provide the facility to place such trades. And a benefit to those traders who make a profit from the activity.

Betting it may be, but when you consider that there is equally no DIRECT economic benefit from buying shares and holding them for the next 50 years in any member company from the FTSE100, is this a significant characteristic anyway? After all, you don't buy your BP shares from BP, and they don't take a direct cut from the transaction.

Moving the train of thought on a step, is there, and why should there need to be, any economic benefit from any market - e.g. art (apart from the artists and galleries, and the buyers of art themselves)?

 

[Martinghoul]

Hi secondary - there is no clear direct economic benefit from trades based on the exchange indices to the exchange participants (member companies, such as those firms in the FTSE100). But there is a huge benefit to those firms that provide the facility to place such trades. And a benefit to those traders who make a profit from the activity.

Betting it may be, but when you consider that there is equally no DIRECT economic benefit from buying shares and holding them for the next 50 years in any member company from the FTSE100, is this a significant characteristic anyway? After all, you don't buy your BP shares from BP, and they don't take a direct cut from the transaction.

Moving the train of thought on a step, is there, and why should there need to be, any economic benefit from any market - e.g. art (apart from the artists and galleries, and the buyers of art themselves)?

That is completely incorrect...

The fact that BP doesn't take a cut from the share purchase doesn't mean that BP doesn't benefit. A company's share price determines its cost of capital, which influences a whole lot of decisions, including whether the firm is a going concern. Just think of Lehman...

And that, as it happens, is one of the economic benefits of the financial markets.

 

[secondary]

zz

 

[Glenn]

When I said Economic benefit of a stock market, I meant the constant auctioning process involved in finding the equilibrium value of the particular stock.

If the derivative index doesn't have this particular benefit. Then what is it for ?

I repeat - the Economic benefit to whom ?
....and you now seem to be talking about individual stocks rather than an Index.
Please be clear about what you are asking. May I suggest that you use an example.

The equilibrium value of a particular stock is determined by the Market maker(s) on that stock. I could go on, but at the risk of yet again misunderstanding your question, I won't. I'm off to bed to get ready for trading tomorrow.

Glenn

 

[robster970]

Index futures are used for hedging purposes when an institution might have a sizeable position in an underlying stock in that index. Index futures also spend time leading what goes on in the index and consequentially drive buying/selling behaviour in the underlying equities.

 

[Martinghoul]

The derivatives, such as futures, provide efficient mechanisms for risk allocation and transfer. A relatively strong no-arbitrage relationship exists between the index and the constituents. Same for the futures and spot. There are people who make sure there's no arbitrage, be they mkt-makers or whoever. That's how a simple hedging/punting activity of someone buying 100 lots of Spooz eventually, through individual share price gains, translates into an economic benefit reaped by the constituent companies.

 

[tomorton]

That is completely incorrect...

The fact that BP doesn't take a cut from the share purchase doesn't mean that BP doesn't benefit. A company's share price determines its cost of capital, which influences a whole lot of decisions, including whether the firm is a going concern. Just think of Lehman...

And that, as it happens, is one of the economic benefits of the financial markets.

Your comment on raising capital is helpful in filling out the picture, but you drew a false conclusion about my knowledge of the mechanics of the stock market because you failed to read my message properly.

Yes, I do recognise there is an INDIRECT economic benefit to BP in my purchase of BP shares, but I was talking about DIRECT benefit (as capitalised for emphasis in original message) because I assumed that's what secondary was talking about. A benefit to BP is certainly that they can e.g. raise additional capital on an increased share price, but that would be an INDIRECT benefit from my purchase, as the capital is not raised from me through this transaction but from a third party in a separate deal.

Clearly, we both know the subject.

 

[Martinghoul]

tomorton, I humbly apologize... In fact, I didn't read your commentary with sufficient attention.

 

[tomorton]

tomorton, I humbly apologize... In fact, I didn't read your commentary with sufficient attention.

Its quite OK. I think this is not a useless coverage of the subject as I did come across someone who thought that company shares are bought from the company or that a % of the cost of the share must go to them from each deal. Mind you, he also thought that occupational pensions were not exposed to the stock market.....