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What is a financial market?

A financial market is a market in which people trade financial securities and derivatives such as futures and options at low transaction costs. Securities include stocks and bonds, and precious metals.

The term “market” is sometimes used for what are more strictly exchanges, organizations that facilitate the trade in financial securities, e.g., a stock exchange or commodity exchange. This may be a physical location (like the NYSE, BSE, LSE, JSE) or an electronic system (like NASDAQ). Much trading of stocks takes place on an exchange; still, corporate actions (merger, spinoff) are outside an exchange, while any two companies or people, for whatever reason, may agree to sell stock from the one to the other without using an exchange.

Trading of currencies and bonds is largely on a bilateral basis, although some bonds trade on a stock exchange, and people are building electronic systems for these as well, similar to stock exchanges.

Within the financial sector, the term “financial markets” is often used to refer just to the markets that are used to raise finance: for long term finance, the Capital markets; for short term finance, the Money markets. Another common use of the term is as a catchall for all the markets in the financial sector, as per examples in the breakdown below.

Capital markets which consist of:

Stock markets, which provide financing through the issuance of shares or common stock, and enable the subsequent trading thereof.

Bond markets, which provide financing through the issuance of bonds, and enable the subsequent trading thereof.

Commodity markets, which facilitate the trading of commodities.

Money markets, which provide short term debt financing and investment.

Derivatives markets, which provide instruments for the management of financial risk.[1]

Futures markets, which provide standardized forward contracts for trading products at some future date; see also forward market.

Foreign exchange markets, which facilitate the trading of foreign exchange.

Cryptocurrency market which facilitate the trading of digital assets and financial technologies.

Spot market

Interbank lending market

The capital markets may also be divided into primary markets and secondary markets. Newly formed (issued) securities are bought or sold in primary markets, such as during initial public offerings. Secondary markets allow investors to buy and sell existing securities. The transactions in primary markets exist between issuers and investors, while secondary market transactions exist among investors.

 

The most relevant financial terms #1 – Dow Jones Industrial Average, Nasdaq Composite and the S&P 500

In these kvootza of posts you will be introduces to the most relevant terms which are being discussed on the financial press. You will be able to debate with your peers and sound like you actually knows a thing or two in financial markets. In this post we will introduce you to the three major indices – The Dow Jones, Nasdaq and the S&P 500.  Let’s go…Deutsche-Bank-Survey-87-of-Financial-Market-Participants-Say-Blockchain-Will-Disrupt-The-Industry-1440x564_c

How is the Dow Jones, Nasdaq, and S&P 500 Calculated?

The S&P 500 , created by Standard & Poor’s in 1962, represents the broadest measure of the U.S. economy among the three major indices. The index value is calculated by weighting each company according to its market capitalization and then a divisor, which is set by S&P, is applied to produce the final value. The simple calculation is as such: sum of the market cap of all stocks included divided by the divisor, or total market cap / divisor.

The Dow Jones Industrial Average , often referred to in short as the ‘Dow’, is the oldest index, dating back to 1896 and is the most globally well known. The Dow represents 30 large cap stocks as determined by the Wall Street Journal. Unlike the S&P 500 and the Nasdaq 100, the weighting for each component in the Dow Jones Industrial Average is ranked by share price, and then a divisor applied to create the final value.

The Nasdaq 100 is the youngest of the three indices having begun trading in 1985. It represents the largest non-financial companies listed on the Nasdaq exchange and is generally regarded as a technology index given the heavy weighting given to tech-based companies. The Nasdaq 100 is based on the market capitalization of its components.

Trading Differences Between Dow Jones, S&P 500 and Nasdaq

Despite the tight correlation between the major U.S. indices, they each have their own ‘personalities’ in how they trade due to the differing make-up for each index and importance of certain companies and groups of companies (sectors). The S&P 500 is the least impacted from day-to-day by any single one stock given it is comprised of so many names. With that said, there are a handful of sectors which have the most importance on the index.

The largest driving sector has changed over the years as various sectors have significantly outperformed or underperformed during various business cycles. For example, back in the 1970s the o il sector was the largest, heading into the top of the 2000 tech-bubble it was Technology, before the 2008 crisis it was Financials, and currently (2018) it is Information Technology (IT), which accounts for a 26% weighting.

The Dow on the other hand, having only 30 stocks, is impacted more significantly by the performance of individual stocks. As it stands, the top 10 stocks account for over 50% of the Dow’s value, making it easy to see how it could be more heavily influenced by strong price fluctuations in only a few tickers.

The Nasdaq 100 is broader than the Dow in sheer number of constituents, but the impact of a smaller group of stocks is even more pronounced. The top 10 stocks in the Nasdaq 100 account for over 50% of the index, leaving 90% of the index to account for less than half of the index’s value. This makes the index top-heavy and highly sensitive to price swings in a select few stocks.

It is worth noting, the time of year when you typically see the largest disparity between the weightings in the indices is during earnings season each quarter, as companies report their results and respond with powerful price swings. The more concentrated Dow and Nasdaq 100 are known to have larger overnight gaps during these periods than the broader S&P 500.

Volatility Differences

Regarding volatility, the Dow Jones is typically the least volatile of the three major indices as many components are slower moving, blue-chip companies such as Boeing Company, United Healthcare, and 3M Company. The Nasdaq 100 is the most volatile of the three largely because of its high concentration in riskier, high growth companies such as Facebook, Amazon, and Alphabet (Google). Volatility in the S&P 500 is typically somewhere between the two.