"An index is a great leveler." |
Stock market averages were first developed in the late 1800s in order to measure the activity of the overall stock market as well as individual sectors and industries within the market. Prior to the 1880s information about stock prices as well as information about a company’s fundamentals were extremely difficult to obtain for the average investor. In response a young reporter named Charles Dow created the “Customer’s Afternoon Letter” to report consolidated stock tables and individual company’s quarterly and annual financials. For the first time in history financial information was available to not only professionals but individual investors as well.
Today there are several averages or indices but the two most important and most quoted are the Dow Jones Industrial Average (DJIA) and the Standard and Poor’s 500 Index (S&P500). The reason these averages became so important is because suddenly investors could immediately understand the direction of the markets and invest accordingly. Soon the idea of mutual funds created an investment vehicle specifically to invest in the companies included in these indices so that investors could reduce their overall risk by investing in a “basket” of equities.
For example, a mutual fund like the Vanguard 500 invests specifically in the companies included in the S&P500 Index. It's also required to invest in the companies in the exact same proportion as the S&P500 itself. The purpose of this is so the mutual fund mimics the exact activity of the S&P500 Index.
Today there are several averages or indices but the two most important and most quoted are the Dow Jones Industrial Average (DJIA) and the Standard and Poor’s 500 Index (S&P500). The reason these averages became so important is because suddenly investors could immediately understand the direction of the markets and invest accordingly. Soon the idea of mutual funds created an investment vehicle specifically to invest in the companies included in these indices so that investors could reduce their overall risk by investing in a “basket” of equities.
For example, a mutual fund like the Vanguard 500 invests specifically in the companies included in the S&P500 Index. It's also required to invest in the companies in the exact same proportion as the S&P500 itself. The purpose of this is so the mutual fund mimics the exact activity of the S&P500 Index.
"Index investing outperforms active management year after year." |
So what does this knowledge of how market averages and mutual funds work provide me with information for my own investing. Well, here’s the edge. At different times some companies are added to the average and some disappear. During these periods when the average is being updated, the mutual fund companies are required to buy the companies that are being added and sell the companies that are being removed from the index. This buying and selling will put upward and downward pressure on those individual stocks.
Today it was announced that Facebook, a social networking company, would be added to the S&P500 Index at the end of next week (20 Dec) while Teradyne, a testing equipment firm, would be removed from the Index. During this transition period it should be interesting to watch Facebook (FB) for upward pressure and Teradyne (TER) for downward pressure as the mutual funds readjust their compositions.
The S&P500 announcement was made after the close today and in after hours trading Facebook is already up $1.98 (4.01%) to $51.36. These two stocks may be worth watching if only for information and entertainment.
Today it was announced that Facebook, a social networking company, would be added to the S&P500 Index at the end of next week (20 Dec) while Teradyne, a testing equipment firm, would be removed from the Index. During this transition period it should be interesting to watch Facebook (FB) for upward pressure and Teradyne (TER) for downward pressure as the mutual funds readjust their compositions.
The S&P500 announcement was made after the close today and in after hours trading Facebook is already up $1.98 (4.01%) to $51.36. These two stocks may be worth watching if only for information and entertainment.
 FaceBook (FB) |  Teradyne (TER) |
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