Trading technology with the Nasdaq index

The performance of the Nasdaq composite index would pique the interest of any investor. Over the past five years it has risen by 171% largely thanks to the performance of a handful of high-profile technology names.

A short history of the Nasdaq exchange

To understand the Nasdaq Composite index, you first need to know what the Nasdaq exchange is. Launched in 1971 it was the world’s first electronic exchange. The Nasdaq’s less rigorous listing requirements made it a target for earlier-stage businesses and it built an enduring reputation as the destination of choice for listings in the technology sector.

A huge success, the Nasdaq continues to attract dynamic businesses from across the world and now has over 3,000 companies listed. It has been widely copied. China, for example, has recently launched its STAR market in an attempt to replicate the appeal of the Nasdaq for its domestic technology sector.

The Nasdaq versus the New York Stock Exchange (NYSE)

The NYSE is the oldest and largest shares-based exchange in the world. While the NYSE and the Nasdaq together account for much of share trading in North America and around the world they are quite different. For example, the Nasdaq is electronic and doesn’t have a physical trading floor. The Nasdaq is also a dealer market - so buyers and sellers do not deal directly with one another - while the NYSE is an auction market, based on Wall Street with set operating hours. Finally, the companies on each tend to differ with the Nasdaq synonymous with technology and innovation while the NYSE leans towards blue chip and industrial firms.

How the Nasdaq index functions

The Nasdaq Composite index simply aggregates the performance of all the companies listed on the Nasdaq, weighted by size. This means it is vast compared to many other indices, with around 2,450 names (some ETFs and other dual stock listings are excluded), compared to just 30 for the Dow Jones Industrial Average (DIJA) or 500 for the S&P 500.

The main Nasdaq index is technology-dominated, but – contrary to its reputation – it only has around half in technology (48%). It also has large weightings in consumer services (19%) and healthcare (10%). Healthcare names include prominent biotechnology companies such as Gilead, Regeneron and Amgen. Nor do these broad categorisations tell the whole story - Amazon.com counts as consumer services stock in spite of its vast cloud computing business.

The top Nasdaq holdings are the familiar technology companies – Apple, Microsoft, Amazon.com, Facebook and Alphabet (owner of Google) – and around a third of the index is in those five stocks alone. Apple, Microsoft and Amazon have around a 10%, 9% and 9% weighting respectively. This largely explains the recent performance of the index. These stocks have had a number of tailwinds in recent years, including lower interest rates, digitisation and the adoption of cloud computing. They have also proved important in keeping people connected during the pandemic.

What is the Nasdaq 100?

The Nasdaq 100 gives concentrated exposure to the top 100 names on the Nasdaq exchange by market weight, known as the Nasdaq 100 companies. Again, the dominant companies are the global technology names mentioned above. (link for compliance evidence Nasdaq 100 Index Component Weights - Nasdaq 100 Companies (slickcharts.com) No follow) As a result, in practice, performance is similar to the main Composite index.

Nasdaq performance is influenced by technology

The performance of the Nasdaq will ebb and flow with technology sector sentiment. In recent years this has been a winning formula, but there have been times in its history where this has not been the case, notably during the technology boom and bust of the late 1990s. From its then peak of 4,907 in March 2000, the Nasdaq fell to just 1,597 over the following year. To put that fall in context, today the index sits at 13,389, but the falls were very painful at the time.

The risk for many of the stocks in the Nasdaq is often not that their business goes wrong, but simply that their valuations become over-extended. Amazon is unlikely to see its growth trajectory fade, for example, but it may be that higher and higher expectations are baked into its share price. It currently trades at around 61x its current earnings and the same is true for many of its peers.

The technology sector can also be vulnerable to shifts in interest rate expectations. Since the announcement of the first successful vaccine in November 2020, inflation expectations have risen. This has notably dented performance of some high growth technology names. The strong long-term cash flows generated by higher growth companies tend to be more valuable when interest rates are low. This has worked well in a low interest rate, low inflation environment, but investors shouldn’t assume that this will endure permanently.

How to trade or invest in the Nasdaq

The Nasdaq indices are among the most widely traded in the world. It is possible to trade Nasdaq futures, Nasdaq ETFs, leveraged Nasdaq ETFs, alternatively weighted Nasdaq ETFs or even inverse ETFs (which profit if the Nasdaq reverses). The Nasdaq has also tended to be more volatile than other indices. For regular traders, it offers a wealth of options.

The Fineco platform offers various options to trade or invest in the Nasdaq, all through one multi-currency account with simple and transparent pricing.