The S&P 500, or Standard & Poor's 500 Index, was created by S&P Dow Jones Indices LLC in 1957. Its constituent stocks include 500 large-cap stocks in the United States. The S&P 500, the Dow Jones, and the Nasdaq are the three key US stock market indices.

The S&P 500 covers about 80% of US stock capitalisation and is followed by many investors as a stock index determining the stock market's direction.(Source SP Global)

It showed an upward trend for about 13 years, from 2009 to 2021. The upward trend gradually slowed in 2022 and entered a market correction situation. As of the end of 2023, the S&P 500 posted a total return of about ~24% for the year, well above its average annual return of around 10%. Technology, communication services, and consumer discretionary stocks have notched big rebounds in 2023.

It shows that the US economy has grown dramatically since the Lehman Brothers collapse in 2008 and the COVID-19 crisis in 2020. In this context, investment trusts, ETFs, CFDs, and other investment products closely related to the evolution of the S&P 500 have attracted attention. This article will examine the features and investment methods of the S&P 500 in detail.

Contents

1. What is the S&P 500?
2. The components of the S&P 500
3. The movement of the S&P 500
4. The outlook of the S&P 500
5. Other typical stock indexes in the United States
6. How to invest in the S&P 500
7. How to trade the S&P 500 CFDs with OANDA
8. OANDA's S&P 500 CFD trading in summary

The S&P 500 Index was developed and maintained by S&P Dow Jones Indices LLC in 1957. The stocks in the index comprise 500 companies selected from listed companies on the New York Stock Exchange (NYSE) and the Nasdaq. The S&P 500 covers about 80% of the US stock market capitalisation. It is closely related to the US stock market.

How is the S&P 500 calculated?

The S&P 500 is calculated using a capitalisation-weighted index.

● The capitalisation-weighted average is calculated by dividing the total capitalisation of each stock by the total capitalisation on the base date.

In simple terms, it is a method of calculating the growth multiplier by comparing past capitalisation with current capitalisation. The benefit of using the capitalisation-weighted average is that it is less affected by value stocks (companies with high stock prices) and more by companies with high capitalisation (large-caps).

Differences between value stocks and high-capitalisation (large-cap) companies

A value stock refers to a company with a high stock price. A high capitalisation company (large-cap) is a company with a high stock price and a large number of stocks issued in the market.

If the number of stocks increases, the capitalisation increases.

In addition to the S&P 500, many stock indexes, such as the Nasdaq Composite Index and Tokyo Stock Price Index ( TOPIX), use capitalisation-weighted averages. The capitalisation-weighted average possesses a drawback as it is disproportionately influenced by companies with higher market capitalisation. This tendency can result in a disproportionate impact on the index due to the dominance of a few large-cap stocks. To address this limitation, alternative weighting methods such as equal-weighted or fundamentally-weighted indices are employed to mitigate the aforementioned issue.

As of December 2023, the top companies are Apple and Microsoft. If either one of the two underperforms, it could affect the performance of the S&P 500. As companies with high capitalisation easily influence the index, it cannot reflect the overall market, which is another disadvantage. Let’s look at the components of the S&P 500.

A constituent stock of the S&P 500 should meet the following criteria (as of December 2023):

1. Constituent companies must be U.S.-based. Stocks listed on eligible US exchanges, as well as real estate investment trusts, can be there. However, closed-end funds, ETFs, American depositary receipts and other specific types of securities are ineligible for inclusion.
2. A company must have an unadjusted market capitalisation of at least $14.5 billion, and its float-adjusted market cap, meaning the portion of shares available for public trading, must meet at least 50% of this threshold.
3. Financial viability is another essential criterion; companies must exhibit positive earnings for the most recent quarter as well as the sum of the past four quarters.
4. Liquidity is also a key factor; the ratio of the annual dollar value traded to float-adjusted market capitalization must be at least 0.75, meaning a substantial portion of the company's publicly available shares are actively traded on the market. This ratio ensures liquidity and that the stock can be easily bought or sold without causing a significant impact on its price.
5. The stock needs to have an investable weight factor of at least 0.10.
6. Lastly, the stock must have traded at least 250,000 shares in the six months leading up to the evaluation date, confirming its liquidity and accessibility to investors.

Source: USA Today

Moreover, the constituent stocks undergo a quarterly review. Regarding the constituent stocks of the S&P 500, the table above delineates the ten companies with the highest percentage of components (as of December 2023). Please note that trading the aforementioned stocks is not guaranteed, and future inclusion is not assured. The industry classification is determined according to the Global Industry Classification Standard (GICS). These companies, including Apple and Microsoft, are widely recognized.

The following chart shows the changes in the S&P 500 (as of December 2023):

We can see an overall upward trend in this twenty year period. However, the S&P 500 does not always continue to rise smoothly. It fell about 500 points due to the Lehman Brothers collapse in September 2008 and lost some 1,000 points because of COVID-19 in 2020. Despite these crises, the S&P 500 still shows strong growth.

Market corrections in S&P 500

Macroeconomic uncertainty, geopolitical instability, and a hawkish FED can drive the S&P 500 (SPX) lower. Overall, we should monitor inflation and monetary policy in the United States.

In addition to exposure to inflation in the US, the S&P 500 is also subject to changes in corporate earnings and the economy. We’ll examine the outlook for the S&P 500 from the following points:

• Inflation in the United States
• US corporate performance and economy
• Setting a long-term upward trend

Inflation in the United States

As discussed in Section 3, the S&P 500 index corrected in 2022.

This is mainly because of the inflation and monetary tightening (interest rate hikes) policy in the United States. The following chart shows the US CPI trend.

In June 2022 there was a 9.1% increase over the previous year and it continued to rise to record levels.

Now let's look at the direction of US interest rates.

The interest rate stood at 4.5% in December 2022. The Fed fund rate at November 2023 stands at 5.5%. With the rise of the CPI, US officials continued to hike interest rates to control price rises. Price corrections in the market are also being observed. In October, the US Consumer Price Index for All Urban Consumers was unchanged, seasonally adjusted (SA), and rose 3.2 percent over the last 12 months, not seasonally adjusted (NSA). The index for all items less food and energy increased 0.2 percent in October (SA); up 4.0 percent over the year (NSA).

The market is at this moment expecting the rates to be held steady for some time to come and some rate cuts, later this year.

US corporate performance and economy

Earnings Per Share (EPS) is one of the indicators for business evaluation. EPS is the amount of profit per share. It reflects the profitability and growth of a company and is followed by many investors. EPS can be calculated through the S&P 500 and is regarded as a leading indicator of the index. The following chart shows the S&P 500 versus the EPS. The orange line in the chart is the EPS while the blue line is S&P500.

The gray sections indicate periods of recession. Once the EPS falls, the S&P 500 will fall as well. Entering a recession represents a more significant decline. The definition of what a recession is varies from country to country.

(The US Department of Commerce uses the NBER (National Institute of Economic Research) economic criteria).

The NBER’s definition of a recession is as follows:

① Downturn in economic activity

② The decline has continued over several months

③ The GDP has fallen

The following chart shows the change in the US GDP over the past few quarters.

For the period January-March 2022, it was down 1.6%, and for the period April-June 2022, the GDP fell 0.6%, showing negative growth for two consecutive quarters. As a result, the United States was considered to be in a technical recession at that time. The economy has shown resilience ever since, and the Bureau of Economic Analysis, an agency embedded in the U.S. Department of Commerce, estimates that as of the third quarter of 2023, the economy grew at an annual rate of 4.9%.

Setting a long-term upward trend

Although the above examines the outlook based on inflation and economic trends in the United States, the S&P 500 shows an upward trend in the long term. Let’s look again at the movement of the S&P 500:

There were short-term corrections during the Lehman Brothers collapse and the COVID-19 crisis. But in the long term, these crises become a turning point for subsequent rallies.

Analysing the inflation and economic trends in the United States can be one of the investment strategies to find a buying opportunity. For ways to invest in the S&P 500, please see section 6 below, ‘How to invest in the S&P 500.’

Apart from the S&P 500, the Dow Jones and Nasdaq are key stock indices in the United States. Therefore, investors in American stocks follow three indexes.

Dow Jones Industrial Average

Nasdaq Index

Russell Index

We will examine each one in detail below.

Dow Jones Industrial Average

The Dow Jones (Dow Jones Industrial Average) is an index of stock prices created and released by Dow Jones (today the S&P Dow Jones Industrial Average). It has been published since 1896 and is the oldest index in the United States. It is a price-weighted index, which means that the index's value is calculated by adding up the prices of its 30 component stocks and then dividing that sum by a divisor that is adjusted for stock splits, dividends, and other factors. This method gives more weight to higher-priced stocks, regardless of their market capitalisation.

What is the Dow stock price?

It is a method of calculating the average stock price developed by Dow Jones.

It can be calculated by ‘total stock price of components ÷ number of components ÷ divisor.’

The Dow Jones Industrial Average features the need to correct the divisor in case of any change in the components.

In this way, the index remains consistent.

The following chart shows the difference between the S&P 500 and the Dow Jones.

The biggest difference is in how it is calculated. Many investors follow this stock index, as with the S&P 500, to monitor the direction of the US market.

The following chart compares the performance of the S&P 500 with the Dow Jones.

S&P 500 vs Dow Jones

The following chart compares the performance of the S&P 500 and that of the Dow Jones over about 2 decades, from 2003 to 2022.

Nasdaq Index

The Nasdaq is the stock market operated by the National Association of Securities Traders.

It focuses on high-tech and IT-related companies and is the largest in the world's stock market of emerging enterprises (venture capital companies).

The Nasdaq market has two indexes:

• Nasdaq Composite
• NASDAQ 100

The Nasdaq in detail:

The Nasdaq Composite index

The Nasdaq Composite is based on the capitalisation-weighted average of more than 3,000 stocks listed on the Nasdaq exchange.

Its components are mainly Apple, Microsoft, Amazon, and other high-tech and IT-related companies.

It helps understand the trends in the high-tech sector.

The NASDAQ 100 index

The NASDAQ 100 is based on the capitalisation-weighted average of the top 100 stocks listed on the Nasdaq.

It focuses on the high-tech sector, and its components do not include stocks from the financial sector.

Unlike the broader Nasdaq Composite, which includes all Nasdaq-listed companies, since the NASDAQ-100 excludes financial sector stocks, it offers a clearer insight into trends within the technology and innovation-driven market segments.

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Changes in the high-tech sector therefore significantly impact the performance of the NASDAQ 100.

The following table shows the differences between the Nasdaq Composite Index, and the NASDAQ 100 .

Now, let’s compare the performance of the S&P 500 with that of the Nasdaq Composite Index and the NASDAQ 100.

S&P 500 vs Nasdaq

The following chart compares the performance of the S&P 500 with that of the Nasdaq Composite and the NASDAQ 100 over some 20 years, from 2003 to 2023.

Russell Index

The Russell Index is an index of small-cap stocks calculated and released by Russell Investments, a US advisory firm.

The Russell 2000 Index is calculated using a capitalisation-weighted methodology, meaning that the weight of each stock in the index is based on its market capitalisation relative to the total market capitalisation of the index. Here's a general overview of how the calculation works:

1. Selection Criteria: The Russell 2000 Index is composed of the smallest 2,000 stocks in the Russell 3000 Index, which is a broader index containing the 3,000 largest US stocks.
2. Market Capitalisation: The market capitalisation of each stock in the Russell 2000 is calculated by multiplying the stock's price by the number of shares outstanding.
3. Weight Calculation: The weight of each stock in the index is determined by dividing its market capitalisation by the total market capitalisation of all stocks in the index. This calculation gives larger weights to stocks with higher market capitalisations.
4. Index Value: The index value is calculated as the sum of the market capitalisations of all stocks in the index, adjusted for any corporate actions such as stock splits or mergers. This total market capitalisation is then divided by a divisor to arrive at the final index value.
5. Rebalancing: The Russell 2000 Index is reconstituted annually to ensure that it continues to reflect the current market environment. Stocks may be added or removed from the index based on their market capitalisation rankings.

Overall, the Russell 2000 Index provides a snapshot of the performance of small-cap stocks in the US market and is widely used by investors and fund managers as a benchmark for small-cap stock performance.

So, let's compare the performance of the S&P 500 with the Russell 2000.

S&P 500 vs Russell 2000

The following chart compares the performance of the S&P 500 and the Russell 2000 over about 20 years, from 2003 to 2022.

Nikkei Stock Average

Although not based in the United States, Japan has several key stock indexes.

One of them is the Nikkei Stock Average.

It is calculated and published by the Nikkei newspaper.

Out of about 2,000 stocks listed on the prime market of the Tokyo Stock Exchange, 225 stocks with high liquidity are selected and calculated based on their average stock price.

In addition, the TOPIX (Tokyo Price Index) is also one of the key stock indexes in Japan.

It is calculated and published by JPX Research Institute of the Japan Exchange Group.

Its calculation is based on a capitalisation-weighted average of about 2,000 stocks listed on the Tokyo Stock Exchange's prime market, adjusted for floating prices.

The following table compares the differences between the Nikkei and TOPIX.

S&P 500 vs Nikkei and TOPIX

The following chart compares the performance of the S&P 500 with the Nikkei Stock Average and TOPIX over a roughly 20-year period from 2003 to 2022.

The US and Japanese economies move in parallel. But compared with the S&P 500, the Nikkei and the TOPIX have not risen as much. There are various ways to invest in the S&P 500, including ETFs and CFDs.

As the S&P 500 is only a statistical number, trading must be based on its derivative products. Currently, the most common instruments for the S&P 500 are ETFs and CFDs.

ETFs are suitable for long-term investment due to their relatively high commissions. If you prefer short-term investments, CFDs are the best option.

Contracts for Difference (CFDs) are financial derivatives that allow traders to trade on the price movements of various underlying assets, such as indices like the S&P 500, without owning the underlying assets. Here's a more detailed explanation of how CFDs can be used to trade the S&P 500:

• Leverage: CFDs allow traders to use leverage, meaning they can control a larger position with a relatively small amount of capital. For example, if the leverage is 10:1, a trader can control a position worth USD10,000 with just USD1,000 of their own money. This amplifies both potential gains and potential losses.
• Two-way trading:
  • Long Position: If a trader expects the S&P 500 to rise, they can open a long CFD position. This means they will profit if the index's price increases.
  • Short Position: Conversely, if a trader expects the S&P 500 to fall, they can open a short CFD position. This means they will profit if the index's price decreases.

• Access to Leverage: Leverage allows traders to maximize their exposure to the S&P 500 with a relatively small initial investment. This can enhance returns but also increases the risk of losses.
• Ability to Go Long or Short: CFDs provide flexibility in trading. Traders can benefit from both rising and falling markets, which is not possible with traditional investing where profits are typically made only when the price of an asset increases.
• No Ownership of the Underlying Asset: Since CFDs are derivatives, traders do not need to own the actual stocks in the S&P 500. This means there are no costs associated with owning the physical shares, such as custody fees or stamp duty in the US.
• Hedging: Investors who hold long-term positions in the S&P 500 or specific stocks within the index can use CFDs to hedge their portfolios against short-term market volatility. For example, if an investor holds a substantial amount of S&P 500 stocks but expects a temporary downturn, they can open a short CFD position to offset potential losses.

• Leverage Risk: While leverage can amplify gains, it also amplifies losses. Leverage trading is high risk and traders can lose more than their initial deposits if the market moves against their position.
• Margin Calls: If the market moves unfavorably, traders may be required to deposit additional funds to maintain their positions. Failure to do so can result in the CFD provider closing the position, potentially at a loss to the trader.
• Counterparty Risk: CFD trading involves entering into an agreement with a broker or CFD provider. If the provider faces financial difficulties or insolvency, the trader might face risks related to the counterparty's ability to fulfill its obligations.
• Market Volatility: The value of CFDs can be affected by market volatility. Sudden price movements can lead to substantial gains or losses in a short period of time.
• Funding charges: Also known as ‘overnight interest,’ it is paid if a position is held from one day to the next. In the case of holding long positions, the accumulated funding charges may result in lower returns.

Start trading S&P 500 CFDS with OANDA is easy:

① Complete the online registration application

② Review your profile

③ Deposit funds (deposit immediately using a funding method of choice. Please refer to the OANDA website for a list of funding methods.)

④ Install a trading platform

⑤ Start trading

OANDA will review your completed application and your account will be ready for funding as soon as it is approved.

Here’s a summary of the S&P 500-related content described in this article.

1. The S&P 500 is a stock index suitable for tracking the trend of the US market
2. It consists of 500 companies listed on the New York Stock Exchange and NASDAQ
3. It is exposed to stocks with high capitalisation, not value stocks
4. The market corrected in 2022, but it is generally expected to rise in the long term
5. You can trade the S&P 500 using CFDs or ETFs. CFDs are suitable for short-term trading, but due to its highly-leveraged nature, losses may exceed deposits if the market moves against you.