How to read key indexes and ratios in stock trading

Once you understand the basics of stock trading , you can start buying blue chips, i.e. “safe” stocks from established companies, in anticipation of dividends or an increase in price. The next step is to explore indexes and ratios. These will help you move beyond well- known companies, in a space where the risk may be higher…but so is the opportunity.

A stock index is a selection of stocks, which are usually weighted based on their price or total market value. There are many different types of stock indexes and they indicate the direction of the overall market. National ones group together the strongest stocks from an individual country’s stock market and reflect the state of its economy, e.g. FTSE 100 is a stock index which includes the top 100 companies in the London Stock Exchange, in terms of market capitalisation. There are also international stock indexes, e.g. the MSCI which tracks a selection of stocks from emerging markets, and industry-specific indexes, e.g. the NASDAQ 100 which tracks technology company stocks. We use stock indexes to describe and compare markets. You cannot invest in them directly but you can invest in instruments which track their performance, e.g. ETFs , options etc.

Stock indexes move in ticks, which represent the smallest possible change in the index’s value, and they are unique to each index, e.g. the S&P 500 moves in ticks of 0.25, the FTSE 100 moves in ticks of 0.50 and the Dow Jones moves in ticks of 1.00. However, a term more commonly used to describe fluctuations is the point: an index has moved by one point when there is a change of 1 in the number before the decimal point. Let’s consider this example: If the S&P 500 increases from 4,018.00 to 4,019.00, it’s increased by 1 point or 4 ticks, because in this index 1 tick equals 0.25.

But what about individual stock ratios?

Indexes, ticks and points help you see where the market is going. Then there are ratios to help you understand the value of individual stocks. The three ratios you’re more likely to come across are:

EPS (Earnings Per Share): The company’s total profits divided by the total number of shares.

P/E (Price to Earnings): The company’s share price divided by its earnings per share. You’ll usually want lower ratios with this one.

DY (Dividend Yield): The annual dividend per share divided by the share value. An interesting ratio, if you’re looking for companies that pay dividends.

Bitesize basics
  • A stock index is a selection of stocks and it’s used to indicate the overall direction of a market.
  • There are national stock indexes, which are linked to a country’s economy, international stock indexes, which track the performance of geographical areas, and industry-specific ones.
  • The smallest possible change in an index’s value is called a tick and it’s unique to each index. A point indicates a change of 1 and it’s more commonly used when talking about market movements.
  • When selecting stocks to buy, you may want to consider ratios, such as the earnings per share, dividend yield and price to earnings.

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