All About Indices
Stock Indices use a portfolio of representative companies (usually spanning major industries) to reflect the status of the whole stock market. There are basically three kinds: global, regional and national.
Global indices include companies regardless of where they are traded. Regional indices include companies from a certain region and national indices include companies from a specific nation. Stock Indices are used to get an indication of the market’s overall direction. Some analysts use them as a barometer of the underlying economy.
Indices can be comprised of tens to hundreds of stocks and each index calculates the weighted average differently. Some weigh the stocks equally (equal weighting), others take company size into account (capitalization weighting) and others use a hybrid method (modified capitalization weighting).
Stock Indices are tradable entities themselves. A currency index is a measure of the value of a specific currency relative to other select currencies. Indices like the US Dollar Index or the Euro Currency Index are used to gauge the strength of those respective currencies.
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All About FX
Currencies are traded on the Foreign Exchange market, also known as Forex. This is a decentralized market that spans the globe and is considered the largest by trading volume and the most liquid worldwide.
Exchange rates fluctuate continuously due to the ever changing market forces of supply and demand. Forex traders buy a currency pair if they think the exchange rate will rise and sell it if they think the opposite will happen. The Forex market remains open around the world for 24 hours a day with the exception of weekends.
Before the Internet revolution only large players such as international banks, hedge funds and extremely wealthy individuals could participate. Now retail traders can buy, sell and speculate on currencies from the comfort of their homes with a mouse click through online brokerage accounts. There are many tradable currency pairs and an average online broker has about 40.
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All About Commodities
Commodity trading covers the buying and selling of a large range of instruments including oil and gas, metals such as gold and silver and soft commodities like cocoa, coffee, wheat and sugar.
Commodities can easily be used to diversify a portfolio of financial assets and manage any correlation issues – meaning that the oil or gold prices will not necessarily move in exactly the same way as the stock or financial markets.
In recent years there has been a marked increase in commodity investment by institutional investors, hedge funds, retail investors and sovereign wealth funds – all of which are looking at the quite depressed traditional investment markets and thinking, ‘where else can we put our money?’
You could also invest in countries that produce commodities – including Australia, Canada, New Zealand, Brazil, Russia and the ‘Stans’ (Kazakhstan, Kyrgyzstan, Uzbekistan and Tajikistan).
Exchange Traded Products (ETPs) are a particular favourite in the commodity markets. They include:
■ Exchange Traded Funds (ETFs);
■ Closed End Funds (CEFs);
■ Exchange Traded Notes (ETNs).
Much of the physical trading of commodities is through individually tailored over the counter (OTC) contracts.
The most popular physical commodities contracts are:
■ Energy – oil, coal, gas products;
■ Metals – gold, silver, platinum and palladium (precious) and copper, lead, zinc, aluminium (base/industrial);
■ Grains and soy – wheat, barley, corn;
■ Livestock, food and fibre – orange juice, cattle, poultry, silk and cotton;
■ Exotic commodities – rare earth elements such as neodymium, dysprosium.
COMMODITY PRICES AND THEIR EFFECT ON FINANCIAL MARKETS
As a discrete asset class, commodities are vital to any diversified portfolio due to their unique characteristics:
■ When equity markets fall, commodity markets tend to rise, and vice versa.
■ The price of equities can go to zero – not true of commodities.
■ There is no credit risk on a commodity. ■ Commodity returns are higher than inflation.
■ Bonds and equities are negatively correlated to inflation (this increases with the holding period), whilst the opposite is true of commodities – thus commodities provide an inflation hedge.
■ Commodities are correlated with inflation, unexpected inflation and changes in expected inflation.
■ Commodity prices can rise even if the economy is going nowhere.
■ War and terrorism push commodity prices up.
■ A precious metal, especially gold, is a safe haven for investors – often replacing cash or treasury bonds as folks become fearful of a weakening US dollar or geopolitical tensions.
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