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Why Trade Index Shares?

I. What are Index Shares?

Index shares, also called Exchange Traded Funds (ETFs), trade on the major stock exchanges like ordinary stocks, but with one major difference: rather than representing an individual stock, each ETF tracks an entire basket of securities.

The first index shares to be introduced (in 1993) were Standard & Poor's Depositary Receipts - also known as SPDRs (pronounced "spiders"). “Spiders” are traded on the AMEX under the symbol “SPY”. Following their successful launch, numerous other ETFs followed, most notably the Dow Diamonds (AMEX: DIA) – representing a basket of the 30 Dow stocks - as well as the NASDAQ 100 index shares (formerly traded on the AMEX under the symbol "QQQ; now traded on the NASDAQ under the symbol "QQQQ"). The QQQQ, better known as the “cubes” or “cubes”, track the NASDAQ 100 stock index. Even though the introduction of the “cubes” is fairly recent (they were launched in March 1999), they have become such a popular trading vehicle that their daily trading volume now rivals that of most companies on the New York Stock Exchange. In fact, only three companies on the Big Board are traded more briskly.

II. Why do we apply technical analysis to indexes (indices) and exchanges, rather than to individual stocks?

The mood of the market as a whole can best be captured by the various indexes, because indexes tend to move in concert with the broad market. Generally, the market dictates the direction of a particular security or ETF (e.g., an index, sub-index, stock, option, or futures contract), never the other way around. It therefore makes sense to get a good grasp on what is happening at the index or stock exchange level. For this purpose, we have found volume analytics (applied to various indexes) to be an excellent vehicle.

III. Why trade index shares?

Index shares are highly versatile trading vehicles - they:

• Provide access to an entire portfolio of stocks with a single transaction: this is perhaps the greatest benefit of ETFs – they give investors and traders instant exposure to a diversified portfolio of stocks;
  
• Can be bought on margin: while we generally do not advocate borrowing money to buy stocks, if done using strict money management rules and by experienced investors/traders, this feature of ETFs can prove highly beneficial;
  
• Can be sold short, even on a down tick (i.e., when the last sale price is lower than the preceding sale price): this is another reason why investing in / trading ETFs can be quite rewarding – and often provide superior returns to mutual funds;
  
• Enable you to trade options and futures on index derivatives;
  
• May be purchased and sold throughout the trading day - in contrast to mutual funds, which are priced only once per day (at 4 p.m.);
  
• Are not associated with high management fees;
  
• Are easy and convenient to trade, as well as highly liquid.

Given their numerous features and benefits, the popularity of index shares has soared in recent years. In fact, ETFs have become an entirely new investment category - representing one of the most flexible, multi-purpose trading vehicles available.

In summary: by trading an index (rather than individual stocks), you eliminate numerous concerns, such as worries about picking the right company, balancing industry weightings, or incurring the costs of trading numerous individual stocks. Best of all, you eliminate the traditional investor predisposition toward taking long positions only (i.e., remove the bias to the upside), allowing you to profit during bull and bear markets alike.

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Copyright 2004 Highlight Investments Group. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.

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