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Stock trading versus index trading

Many investors are faced with the decision of whether to trade indexes or stocks. If this is you, it can be helpful to establish what each one involves while assessing the pros and cons of each.

Trading stocks means you can directly purchase shares of individual companies. Stock market updates are well documented and there are frequent updates on different companies’ share prices rising and falling in the news. Meanwhile, trading index derivatives means you have exposure to total market segments. Popular index funds include the S&P 500 index, which contains 500 top publicly traded companies in the U.S. We regularly see news updates about this index fund.

Here’s what you may want to consider when deciding whether to engage in stock trading or index trading.

Performance potential

Indexes allow you to trade a range of stocks in one go. For example, the S&P 500 includes companies like Amazon, Microsoft and Apple Inc. You can also choose indexes that reflect a particular market. This means that the performance of numerous companies will dictate how well the index performs.

On the flip side, trading individual stocks means you could receive higher returns where a company has performed better than the market.

Risk management

With index trading, the diversification element means you spread the risk across several companies, rather than putting all your eggs into one basket, where you trade one company’s stocks and shares. If one company within an index performs poorly, you have the cushioning of other companies’ performance.

Meanwhile, stock trading means you are reliant on a single company’s performance with less to fall back on. Poor performance on the stock market stems from a range of factors, ranging from competition threats to industry-related restrictions that can hinder company growth. Much of your decision will come down to your risk tolerance and assessing how much you can afford to invest or lose.

Market fluctuations 

Market performance dictates how well stocks perform. That’s why stock trading is considered a more volatile approach as market fluctuations can be drastic. A single company announcement or earnings report can cause the share price to rise or fall significantly.

Indices are less volatile. Their price movements tend to be more predictable, which means you could build steady wealth over time as these are dictated by a joint set of performance results.

Diversification and portfolio management

Index trading offers inherent diversity benefits, which is something that is encouraged for successful trading and investing. This is because a single investment or trade exposes you to several stocks. Diversification is good for reducing portfolio volatility – if one stock performs badly, the performance of others will help to absorb this loss.

Stock trading tends to be higher maintenance. You’ll need to actively manage your portfolio and implement your trades one by one which, for a less experienced investor, can be overwhelming. It requires you to regularly monitor how well the stocks perform too.

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