COVID-19 and its continued fallout have battered markets over the last couple of years, reflecting in global supply chain and supply issues. Now that Russia’s invasion of Ukraine has further undermined our confidence, global stock indices are suffering in 2022.
The last few months have been particularly rough, with some major index losses reachingdouble-digit territory. Stock indices are also reacting to the turbulence caused by soaring inflation, which is itself not far away from reaching double digits.
Does that Mean You Shouldn’t Trade Indices?
Volatility can hurt, but it also brings great trading opportunities. Dire outlooks result in depressed prices, and depressed prices can be the best time to buy an asset. This is especially true of stock indices, which represent a basket of stocks thattraders can trade like individual securities.
While individual stocks might not be able to weather the declines of the current economic climate, markets do rebound, eventually reaching new heights. That’s why a down market is a perfect time to buy stock indices.
Why Trade Indices?
Harry Markowitz won the Nobel Prize for developing modern portfolio theory, which he introduced in a paper in 1952. The core tenant of modern portfolio theory is that properly diversified investments can protect returns while nearly eliminating risk.
The best way to diversify investments is through buying indices. Over time the market grows. Then it “corrects” or falls. Then it riseshigher. The cycle continues.
The point is that stock indices survive corrections to rise even higher over a long enough horizon. This is not true of individual stocks; there are plenty of reasons companies can fail.
How to Survive Tech Stock Failures
High-tech stocks are an excellent example. The success of a new technology depends on two things: the successful deployment of the technology as well as its adoption.
People can want a technology, but a particular company might fail before successfully developing it. Or the technology works, but people don’t want it. Either way, if a traderhas money in the stock of a company that fails, a trader stand to lose up to his entire investment.
Choose a Tech Index Instead
But instead of an individual stock, if a trader put his money in a tech index, like the NASDAQ 100 Technology Sector Index (NDXT), the trader significantly decreaseshis chances of losing money.
One company’s failure is often another company’s gain, highlighting the critical advantage of index investing. Mathematically, traderscan maximize the expected returns of the individual securities by investing in an index over buying individual securities.
Trading in National Indices
National indices also present opportunities during troubled times. When market corrections strike, emerging economies often take more of a hit than developed ones, driving down their national stock indices. But then they have that much higher to go to reach normal levels once the economy recovers.
When trading in national indices, a good strategy is to look for those that reflect political systems that support the free market, low corruption, and most importantly, investors’ rights.
When considering investing in a national index, look at the country’s Corruption Perception Index profile. Higher levels of corruption cause economies to fail and their national indices as well.
How to Find Indices to Trade?
Despite current market insecurities, traders can find indices to trade right now. Buying these depressed indices might be this decade’s best opportunity to find strong trades.
The best indices to trade are the ones that traders are confident will eventually recover. Look for indices representing established economies, influential individual sectors, or emerging economies that embrace free-market principles and have laws protecting investors.
Difficult times can be some of the best times to trade in the long run, especially when diversifying your risk by buying stock indices. Currently, prices are low, but they will rise again, and probably soon.
Disclaimer: The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.