Financial planning training – Why trade index, not stocks

Financial planning training – Investopedia defines an index as “An aggregate value produced by combining several stocks or other investment vehicles together and expressing their total values against a base value from a specific date. Market indexes are intended to represent an entire stock market and thus track the market’s changes over time.”

People will often speak of the market as a whole while analyzing one of the more popular indices such as the Standard and Poor’s 500 index, or the Dow Jones Industrial Average. Under financial planning training we will discuss these too.

Trading an Index

There are a variety of ways to trade an index. Of course, to buy one share individually of every company within an index would be very expensive. But here are some other ways to trade an index for far less.

  • Index futures (e.g. E-mini’s)
  • Index future options
  • Index-based mutual funds
  • Index-based Exchange Traded Funds (e.g. QQQQ)

The choice an investor makes as per financial planning training on which investment vehicle to ride largely depends on his goal. If he wishes to buy and hold over an extended period of time, either of the index-based funds might be a better choice. If he is looking for high leverage, the e-mini based on index futures might be a good choice. As well, if he wants extreme leverage he might choose index future options that are subject to time decay.

Advantages to Index Trading

There are many reasons why people trade indices instead of individual stocks and one should abide by it under financial planning training. Here are a few of them:

  • Better leverage than trading stocks on margin
  • Less technical analysis
  • No screening stocks for fundamental data
  • High liquidity

Simply put, investors are able to spend more time on analyzing one chart, then trying to screen through thousands of stocks for the right company. Much time is saved from not having to analyze financial reports. The trader will spend most of his time looking at the big picture and overall market sentiment.

The leverage possible with mini future contracts or options creates a profitable environment for even trades of a few percent index gains.

The highly liquid market also creates tighter spreads which translates into less money spent per transaction.

Is Index Trading for Everyone?

Granted in financial planning training, some will no doubt prefer to screen and attempt to find the stock that has the potential to double during the year. Others will want to trade investment vehicles without any leverage as this creates more stability. Today’s market has many choices available to cater to the gamut of risk and reward scenarios. Index trading is just one such vehicle.

Blue Chip versus High Growth Stocks

Whether a volatile high growth stock is better than a blue chip company depends on how a person trades and under financial planning training we will take a brief look to both.

The Argument for Blue Chip Stocks

The argument for blue chip stocks is that someone can invest and forget about it. A higher-quality stock should be able to produce a decent rate of return over the long term. At least that is what an advocate for the ‘buy and hold’ ideology would say. But is this actually the case and importance of financial planning?

If an investor bought blue-chip company stock in 1975 for 10 dollars per share, the price would need to be worth 40 dollars and 14 cents by 2009 just to keep up with inflation as tracked by the Consumer Price Index. While many blue-chip companies will vastly outperform these figures, many businesses will also dissolve into insignificance or go bankrupt. Who could have guessed the downfall of so many banks and automaker companies during 2008 and 2009?

The Argument for High Growth Stocks

On the other hand looking at the importance of financial planning, promoters of high growth stocks investing will point to stocks such as Google that soared to seven times its IPO price in under four years. The counter-argument would be if someone timed their entry and exit wrong, they could lose half of the investment in just over one year on the very same stock. Volatility is dangerous.

So which is a better investment?

The Tale of Two Methodologies

An investor who does not wish to actively manage his portfolio should seek the aid of a highly regarded wealth manager instead of trying to guess which company is a good long term investment. This is one of the main mantras in the importance of financial planning. The market, as tracked by the Down Jones Industrial Average, is trading marginally above where it was 10 years ago. This suggests that buying and holding an average stock in this index would be a poor investment over the last decade.

The investor who does not mind actively trading both bull and bear markets may find more profits in high growth stocks than blue chips. Why?

The High Growth Stock is a Two Edged Sword

Well respected investor William J. O’Neil, author of How To Make Money Selling Stocks Short, will tell anyone that high-growth stocks will be leaders in bull markets, but often fall the hardest during bear markets. If a trader can find a consistent method to trade high-growth stocks long in up markets and short in a down markets, his profits will dwarf the buy and hold investor. But that is a big ‘if.’

How does one trade high-growth stocks without the market crushing him like an elephant sitting on a grape is the question under importance of financial planning. One way is to use a system that times buy and sell transactions with market sentiment. An example of this is swing-trading. The other is much simpler and involves the use of protective put options on high growth securities. Both methods will be discussed in future articles.

Whether a trader uses the slower paced blue chip stocks, or the more volatile high growth stocks to invest in, both can yield good results with due diligence.

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Author: knowledge herald

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