Exchanges, Indices, and ETFs

By: Eli Levi  |  December 19, 2021

By Eli Levi, Business Editor

Exchanges, Indices, and exchange-traded funds (ETF) are all crucial aspects of understanding the trading market.

When businesses first go public or sell a part of their company to raise capital, it is called an initial public offering (IPO). Initially, raising money was the main reason for companies to go public. Due to an abundance of private equity and venture capital firms nowadays, however, most companies do not need to go public to raise money. Rather, many companies go public nowadays so that the founders and major shareholders of the company can sell their shares of the company and receive profit. Stock exchanges serve another function in that they are a centralized place to buy and sell stock in a market regulated by the Securities and Exchange Commission (SEC).

Stock exchanges function as a place to exchange stocks for money or vice versa in a public manner. There are many different stock exchanges all over the world. The two major United States exchanges are the National Association of Securities Dealers Automated Quotations (Nasdaq) and the New York Stock Exchange (NYSE). These exchanges are open to trade the listed stocks and indices from 9:30 am to 4:00 pm on Monday to Friday. 

Indices mimic a market or set of companies within a market and are a great mode of investing for the passive investor. Passive investing in this case would mean using a buy-and-hold strategy, which involves buying and holding an index, stock, bond, etc. for a long period of time and then selling after the gains have compounded. There are three major indices: the S&P 500 (Standard and Poors), Dow Jones Industrial Average (DJIA), and the Nasdaq 100 Composite. The S&P 500 tracks the top 500 public U.S. companies by market capitalization. Market capitalization, commonly referred to as market cap, is the total value of all of the company’s shares of stock. There are certain criteria other than the market cap that are necessary for inclusion in the S&P 500. One example is that any company that is to be included in the S&P 500 has to have been profitable in its most recent quarter and the sum of its trailing four consecutive quarters. A recent example of a company that had a large market cap but did not fit this criterion was Tesla. Tesla was not profitable until last year, finally making it eligible to be added to the S&P 500

The Dow Jones Industrial Average tracks 30 public companies in the U.S., picked by the Wall Street Journal and heavily weighted in industrial-based stocks as opposed to technology-based stocks. The Nasdaq 100 Composite is composed of the top 100 public US companies by market cap, excluding stocks in the financial sector such as banks, insurance companies, and real estate brokers. Other indices include the Russel 2000, Barron’s 400, MSCI China, and MSCI Japan. 

One method of purchasing indices is through an EFT. ETFs are comprised of and track multiple different stocks, meaning the ETF owns shares in multiple different companies. An example of an ETF is the Standard and Poor’s Depositary Receipt, which tracks the S&P 500 index, which enables them to own shares in those 500 companies. There are also actively traded ETFs which not only buy and hold individual companies but also trade multiple different stocks on a daily basis. Actively managed ETFs usually follow a specific strategy of investing and are bought and sold based on that strategy.

Understanding how to invest is integral to building wealth over time. Knowing some of the basics about exchanges, indices, and ETFs is a step towards financial independence.