If you’re starting to learn how to trade, you should understand the basics first. As one of the most popular financial instruments that allows traders to understand indices, you should be aware of them. However, since the index is a broad category, you can start by focusing on a smaller type of index, such as sector-specific indices.
The sector-specific index is the basket of shares related to sectors, including energy, industrial, and financials.
In this article, we’ll dive into the things you need to understand as a beginner in the trading world.
What Are Sector-Specific Indices?
As mentioned, a sector-specific index consists of underlying assets or stocks under a specific sector in the economy. These stocks are groups based on their sectorial characteristics, such as energy, information technology, healthcare, and finances.
For instance, in the financial sector, there’s the MSCI World Financials Index which provides the financial situations of global markets, both emerging and developed.
So, if you’re looking for an index that you can practise your trading strategies, you can start with the sector-specific indices.
Importance of Sector-specific Indices
Just like any other type of index, sector-specific index is essential in the economy. Here are some of the reasons why:
- Competitive Benchmarking: Comparing the performance of a single stock that’s included in a sector-specific to its performance in the index allows you to identify the status of a company’s performance.
- Diversification Strategy: As you know, one of the risk-management tips is to diversify your portfolio. It allows you to gain exposure to various companies without the need to own individual stocks.
- Identifying Market Trends: Since all assets in a sector-specific index belong to the same industry, you can easily identify whether a certain sector is rising. So, when there’s a movement in the market value of stocks, the companies can easily inform their investors of the current status.
- Hedging Against Risks: Since not all sectors move the same way, there are instances when one sector depends on the economic cycle. Fortunately, with sector-specific indices, you can easily hedge against risks and make informed decisions.
How are Companies Chosen?
When it comes to choosing the companies to be included in a sector-specific index, here are the most common criteria used.
- Market Capitalisation: An index should consist of companies that meet the market capitalisation threshold. So, if a company can’t compete in the business industry, it’s possible that it won’t be included in the index.
- Liquidity: Aside from being able to meet the market capitalisation threshold, the stocks should be sold and bought in the market easily.
- Sector Representation: Although it’s a sector-specific index, there’s still diversity when it comes to the companies included. For instance, in the energy sector, an index can include companies under services and equipment, oil production, and renewable energy companies.
Key Examples of Sector-Specific Indices
1. Technology Sector
- Dow Jones U.S. Technology Index
As a US-based index, the Dow Jones U.S. Technology Index consists of technology companies from various market capitalisations.
- S&P 500 Information Technology Sector Index
The S&P 500 Information Technology Sector Index represents the technology companies under the S&P 500 Index.
2. Healthcare Sector
- MSCI World Health Care Index
Focuses on the performance of the international healthcare companies.
- NASDAQ Biotechnology Index (NBI)
Represents the healthcare sector from the NASDAQ Stock Market.
3. Financials Sector
- FTSE All-World Financials Index
- MSCI World Financials Index
Both indices are trading the performances of financial companies around the world, established and emerging.
4. Energy Sector
- S&P 500 Energy Sector Index
The energy sector involves the renewable energy, gas, and oil companies under the S&P 500.
- MSCI World Energy Index
On the other hand, the MSCI World Energy Index tracks the global operation of companies in the energy sector.
How to Use Sector Indices in Your Investment Strategy?
If you’re planning to include sector-specific indices in your trading strategy, there are things you should consider.
- Focus on Long-Term Trends: Although sector-specific indices can be traded in the short term, you should still look after the long-term trends for more trading opportunities.
- Combined with Broader Market Analysis: Since sector-specific indices are under a broader index, don’t forget to include the main index in your analysis.
- Use Sector ETFs: Exchange-traded Funds (ETFs) in sector-specific indices are also available if you don’t want to own individual stocks, but still get the exposure.
- Rebalance Based on Economic Cycles: As mentioned, different sectors have different reactions to the economic status. For instance, one sector can rise during an economic phase, while another might fall. So, you should always keep this in mind when creating trading strategies.
Final Thoughts
The sector-specific index is one of the many things you should understand when entering the world of index trading. In doing so, you can create a more effective strategy, and make informed decisions along the way.
If you want to share your thoughts about this, don’t hesitate to leave a comment below!
ABOUT THE AUTHOR
Aliana Baraquio has over 5 years of experience as a writer and market analyst. She specialises in developing beginner-friendly trading techniques and tutorials. Additionally, she suggests FP Markets as the top broker for trading CFDs and Forex.