If you’ve been watching the news over the past couple of months then there’s a good chance you’ve heard the term ‘footsie’ or ‘footsie 100’ being bandied about by stern-faced reporters.
The phrase is an informal reference to the FTSE 100, a stock index that’s used by financial professionals, investors and media figures on a daily basis.
They do so because the index provides a good benchmark by which to gauge the performance of the UK’s economy and their own investments.
If the index is going up in value, it usually means the UK economy is doing well. If the reverse happens, as has occurred over the past couple of months, then the opposite is true.
Wait….what’s an index?
All of this probably makes no sense if you don’t know what an index is.
In simple terms, an index is a set of stocks, with some common feature, that are grouped together and used to analyse how a particular market is performing.
For example, the S&P Global Oil Index is comprised of 120 of the largest publicly-traded oil and gas companies in the world. Viewed as a whole, these companies can give investors insights into how the energy industry is performing.
The FTSE 100 is made up of the 100 highest value, publicly-traded companies in the UK. The highest value in this instance is determined by a company’s market capitalisation — the total value of all of its shares.
These values fluctuate as a company’s share price changes, which means the companies in the index change too. The London Stock Exchange Group, which owns the firm that puts the FTSE 100 together, reviews the index every three months and moves firms in and out of it. M&S famously dropped out of the index last year, sending shockwaves through the home counties.
How old is the FTSE 100?
To uncover the origins of the FTSE 100, we have to take you way back to 1983. Margaret Thatcher was prime minister, Return of the Jedi played to sold-out cinemas and Culture Club topped the charts with Karma Chameleon. Those were the days, eh?
Anyway, Lady Thatcher is important here because her deregulation of the financial markets led to the establishment of the London International Financial Futures Exchange (LIFFE) in 1982.
As its name suggests, LIFFE — which still exists — is a futures exchange. Futures are contracts in which one party agrees to pay a preset amount for a certain asset at a future date.
To improve its futures contracts and help its clients hedge their exposure to risk in the stock market, LIFFE decided to create a new index that would be superior to the existing FT30. This is another index, created in 1935, that tracks 30 companies in the UK. Though it still exists today, it’s not commonly used by financial professionals.LIIFFE on the trading floor
In 1983, the FT30 was only updated once an hour and had restrictive rules governing which companies could be included in it.
LIFFE wanted to create a new index, made up of the 100 largest companies in the UK by market cap, that would be updated every minute. The London Stock Exchange was brought into the equation soon afterwards and the index was all set to be named the SE100 until the Financial Times’ editor, Richard Lambert, convinced the exchange to continue its association with his paper.
Thus was born the Financial Times Stock Exchange 100 index or, as we more commonly know it, the FTSE 100.
What’s it used for?
As you can see above, one of the most important ways that the FTSE 100 is used is to create futures contracts. It’s also used to make options. These are similar to futures and give investors the right, but not the obligation, to buy an asset at a set price on a fixed date.
Futures and options are what investors call derivatives — financial securities whose price is derived (get it?) from an underlying market or asset. They are generally used by more experienced investors to hedge risks or, in some cases, for speculation.
Aside from this, the FTSE 100 is regularly used as a benchmark for investors to gauge how successful their investments have been. Let’s say that, in a given year, the FTSE 100 increased in value by 10 per cent. If an investor had a portfolio of comparable stocks, which increased by 15 per cent in the same year, they’d have done a good job (or got lucky!).Corona crash
The reason for this is that, though it may sound simple, beating the market isn’t easy. Many professionals regularly fail to invest in stocks that increase in value more than the overall market does over a set period of time.
Lastly, the FTSE 100 acts as a barometer for the wider economy. If the overall value of the 100 most valuable companies in the UK is declining, it probably means that the economy is in trouble. We’ve seen this over the past couple of months, with the index losing over 20 per cent of its value as the coronavirus spread across the world.
Investing in the FTSE 100
Some companies and media outlets will make it seem as though you can ‘buy’ or ‘trade’ indices like the FTSE 100.
This is slightly misleading. An index is not a security but a collection of data that tells you how a specific market is performing, so you cannot ‘buy’ one.
That doesn’t mean it’s impossible to invest in real assets that closely mirror the performance of the FTSE 100 or other indices. If you had a lot of money, you could just buy the right number of stocks in all of the companies on the list.
So much footsie
As that’s time-consuming and expensive, many people prefer to put their money into index funds.
If you open your Freetrade app, you’ll see things called ‘exchange-traded funds’ or ‘ETFs’ that track many indices, including the FTSE 100. The companies that put these together invest in the stocks in the index directly, and let you invest in them indirectly by buying an ETF unit.
Putting money into ETFs is a popular way of building a more diversified portfolio with less expense and effort than you might achieve by buying individual stocks. Some ETFs invest in narrower indices and sectors, but typically will still provide greater diversification than a small portfolio of individual stocks
ETFs are not the same as another widely sold product known as a ‘contract for difference’ or ‘CFD.’ These are high-risk investment products which let people speculate on short term price movements on indices and other assets.
A significant thing with CFDs is that you never own any stocks. You just have a contract, under which you promise to pay the counterparty and the counterparty promises to pay you, depending on whether you lost or gained in the transaction.
Some investors choose to invest in both ETFs and individual stocks, the idea being that they could make bigger gains via those individual stocks but, if they end up losing on them, those losses could be offset by their ETF investments.
There’s a huge debate as to the merits of investing in ETFs versus picking stocks, judging which is superior and why you should choose one over the other. But it’s a long debate. One we’ll have to save for another Weekend Read….
This is a companion discussion topic for the original entry at https://freetrade.io/post/what-is-the-ftse-100