Forex Investment and Currency Trading

It would be overwhelmingly complex and confusing to literally track every stock. Instead, professional money managers, investors, journalists, and everyone else rely on indexes of selected stocks to represent the broader market.

The Dow

Launched in 1896 by Charles Dow (who also founded the Wall Street Journal), the Dow Jones Industrial Average broke new ground in American stock market history by using a selected group of stocks to measure the direction of the markets as a whole.

Dow and his colleagues continued adding stocks to the index until it reached the current total of 30 in 1928. Since then, each time a stock has been added to the Dow, one has been removed. According to Dow Jones literature, “A stock typically is added only if it has an excellent reputation, demonstrates sustained growth [and] is of interest to a large number of investors.”

Under these vague guidelines, the Dow today betrays its roots in the era of industrial America, with technology and service companies underrepresented. Coca-Cola and General Motors are in, Cisco and eBay aren’t. Even mighty Microsoft didn’t make it into the Dow until 1999.

So why is the Dow still so widely cited? For one thing, it remains a reasonably accurate snapshot of how large American companies are doing. But its longevity and status as the first modern stock index are probably the main reasons—one more example of how perception can shape reality in the markers.

The Standard & Poor’s 500
The S&P index has a long history, too. It launched in 1923 with 225 stocks and reached the current 500 in 1957. With more stocks man the Dow, the S&P includes all major industries and is regularly updated to mirror changes in the overall markets. In short, it’s a more balanced and representative sample of the U.S. stock market as a whole.

The largest companies in the U.S. markets are virtually all in the S&P 500. In fact, the stocks it includes make up about 80 percent of the value of the U.S. markets. Because it is big and broad, the S&P is the basis for much professional analysis of the markets.

The NASDAQ
Unlike the Dow and the S&P, the NASDAQ Composite is made up of all the stocks listed on a single exchange. Founded in 1971, the NASDAQ was the first stock market to be entirely computerized— hence its name: the National Association of Security Dealers Automated Quotations.

Its electronic approach, combined with lower fees and easier standards for listing, attracted fledgling technology companies. In the 1990s, many of those firms grew up fast. NASDAQ-listed newcomers such as Microsoft, Apple, Cisco, Intel, and eBay propelled the index from an upstart to a power player, and the NASDAQ’s explosive growth was followed by legions of technology bulls.

Since then, the NASDAQ’s value has declined, along with that of many of the technology stocks listed on it. But despite those negative perceptions, the NASDAQ remains a reasonable indicator for American technology stocks.

What About foreign Markets?

Sure, the United States is the 800-pound gorilla of the world economy. But the European Union, Japan, China, India, and other areas aren’t exactly 98-pound weaklings. And the very size of the U.S. economy means that the rest of the world is less developed by comparison, leaving room for greater future growth.

You can benefit from at least some of that growth by owning stock in U.S. corporations. For example, roughly 70 percent of Coca-Cola’s revenue and operating income in 2004 came from countries outside North America.

But you can also expand your investing horizons to include companies listed on foreign stock exchanges. -Many foreign companies make it easy by letting you buy and sell their stocks in dollars on U.S. markets through American Depository Receipts.

When you invest in foreign stocks you Have to consider more than just the company and industry you are buying—you also have to factor in currency exchange. If a company’s home currency rises or falls against the dollar, it usually won’t outweigh business realities, but it can make a big difference in your results. Political risk is another factor. Coups, wars, and other events can stop a company in its tracks. These two factors aren’t a big worry for stocks in countries such as Germany or Japan. But for less-developed nations, the combination may simply be too much for individual investors to manage, and mutual funds may be a more realistic choice.

Translating the Foreign Indexes
Perhaps the best-known international index is the MSCI EAFE (Morgan Stanley Capital International Europe, Australasia, and Far East Index), known to traders as “ee-fuh” or “ee-fee.” As the name suggests, it includes large companies from much of the world.
If non-U.S. economies continue to grow faster than ours, we can expect to read more about country-specific indexes, too. The indexes for the markets in London (FTSE), France (CAC), Germany (DAX), and Japan (Nikkei) are already widely published. In the future, we may find ourselves following indexes tracking the stock markets of China, India, Brazil, or other emerging countries, too.

Market Terms

Bull markets are periods when stocks are going up. The phrase derives from the German “to roar”. Bear markets are periods when markets are going down. The term bear market is thought to derive from the proverb “to sell the bear’s skin before one has caught the bear”, or what we now call short-selling – that is, hoping to profit from a decline in a stock price. The idea is to sell shares one doesn’t own now to be delivered later, by which time we’re hoping that the price will have fallen. There’s no single definition of how long or deep a rise or fall must be to qualify as a bull or bear market. But a change of plus or minus 20 percent or more, lasting at least 2 months, is a reasonable standard.

American Depository Receipts were created more than 75 years ago as a way of buying and selling foreign stocks in U.S. markets. Banks create ADRs by buying a block of foreign stock and reissuing it for sale. The bank handles all the foreign currency conversion, so the stock trades in dollars, usually with the letters ADR following the company name. ADRs are usually priced very close to the shares of the stock in its home market, though there can be differences because markets operate in separate time zones. For instance, because the Tokyo market closes in the wee small hours of the New York morning, an ADR on a Japanese stock and its local share never trade at the same time.