Index trading can be a useful tool for traders who want to get an idea of ​​the fortunes of a certain country, sector or genre. There is no shortage of different indices produced, but the ones we know the most are perhaps those for blue chip stocks. The in London, the in Frankfurt, the in Tokyo, and so the list goes on. However, two indices that are often of specific interest are the and both of which relate to many of the largest stocks on Wall Street.
The S&P versus the DOW
The S&P is composed of 500 of the largest listed companies in the US and is weighted by market capitalization. The more the company is worth (shares in issue multiplied by the share price itself), the greater the weight in the index. Microsoft (NASDAQ :), Apple (NASDAQ 🙂 and Amazon (NASDAQ 🙂 are currently the three largest stocks in the S&P 500, together accounting for just over 10% of the index. Companies such as Gap (NYSE 🙂 are currently among the smallest voters. Gap is currently in 489th place and represents only 0.024% of the index.
The Dow, however, is subtly different. It looks at the performance of only 30 of the largest (not the 30 largest) US listed stocks and is calculated based on something called a price-weighted index. That means that the companies with the higher share price – not the market capitalization – are the ones that put the most weight on it, also taking into account factors such as historical stock splits and dividend payments. The oddity has certainly produced some abnormal price performance for the index in the last week.
Due to its unusual structure, Boeing (NYSE 🙂 is currently the largest constituent of the Dow, accounting for nearly 10% of the index and with a market capitalization of $ 210 billion. Pfizer (NYSE 🙂 is currently the smallest component in the Dow, which represents only 1% of the index and yet has a market capitalization of $ 225 billion. The collapse of 10% of Boeing's share price on March 11, following a second tragic accident with a new version of the 737, was therefore sufficient to have a meaningful impact on the index as a whole.
What does this tell us about trade in the S&P versus the DOW?
The S&P has a more traditional weighing method, so it is unlikely that it will be exposed to significant shocks.
However, the S&P has a big weight in the three tech giants – Apple, Microsoft and Amazon. If all three sell these in unison, it could make quite an impression on the index.
The Dow lacks diversification. The Dow consists of only 30 shares and four of them represent nearly 30% of the index, so the Dow will be subject to higher levels of short-term volatility than the S&P.
But in the longer term, the volatility of the Dow and the S & P is closely linked.
The numbers
The CBOE – Chicago Board of Exchange – conveniently calculates a number of volatility indices, including the (for the S&P 500) and the (for the Dow Jones Industrial Average). The figures are based on real-time prices of options on the respective underlying index and are designed to reflect a consensus of the expected volatility on the stock markets in the coming 30 days. Sometimes these statistics are & # 39; anxiety meters & # 39; mentioned – the higher the index, the greater the expectation of volatility in the coming month.
The graph above shows the correlation between the volatility meter for the S&P 500 and the Dow 30 at the start of each week, dating back to the beginning of the decade. Week-1 is the week that starts on March 10, 2019. As can be seen, there is little difference between the two metrics.
However, looking at the average range posted by each index shows a very different story. In an average week of the past nine years, the VIX showed a range (calculated by the weekly peak minus the weekly low, divided by the weekly low) of 24%. Compare that with the VSD for the less diversified DOW and the average range of the index comes in with a shadow of more than 36%.
The takeaway meal
With this in mind, the figures show that intraday traders may be able to favor the Dow in the short term, given the higher levels of short-term volatility. Conversely, those who want to trade a longer-term trend may want to consider the S&P.
