A:

To answer this question, we should first define exactly what an index fund is. An index fund is a mutual fund, or a basket of stocks sold by a mutual fund company, that attempts to mimic or trace the movements of a given index.

You can buy index funds for numerous different indices, including the S&P 500, the Dow Jones Industrial Average and the Russell 2000. With an index fund, you are buying ownership into a portion of a portfolio composed of stocks that are weighted in such proportions as to track a desired index.

A trader engages in shorting when he or she borrows a security, usually from a broker, and then sells it to another party. The short seller hopes the security's price will go down so that he or she can pay a lower price when buying back the security to return it to the lending party. If the short seller is successful, he or she will profit from the difference between the price at which the security was sold and the lower price at which it was bought back. Because you purchase and redeem mutual fund units from the mutual fund company and (generally) not on the open market, you can't short an index fund.

However, as technology has evolved in other areas of the economy, it has also done so in the financial sector. The need for an index-tracking, stock-like security was recognized and the security known as an ETF, or exchange traded fund, was born. An ETF's value is tied to a group of securities that compose an index. Investors are able to short sell an ETF, buy it on margin and trade it. In other words, ETFs are traded and exploited like any other stock on an exchange.

ETFs attempt to track a given index, so they fluctuate in price throughout the day as the index fluctuates in value. However, as an ETF's price depends on the forces of supply and demand (which change with the movement of the underlying index), an ETF might not track the market in perfect unison. But most ETFs usually come very close - they're typically within less than 0.5% of where the index is.

RELATED FAQS
  1. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  2. What is after-hours trading? Am I able to trade at this time?

    After-hours trading (AHT) refers to the buying and selling of securities on major exchanges outside of specified regular ... Read Full Answer >>
  3. Are target-date retirement funds good investments?

    The main benefit of target-date retirement funds is convenience. If you really don't want to bother with your retirement ... Read Full Answer >>
  4. Do mutual funds require a demat account?

    A dematerialized account enables electronic transfer of funds. The account is used so an investor does not need to hold the ... Read Full Answer >>
  5. How liquid are Vanguard mutual funds?

    The Vanguard mutual fund family is one of the largest and most well-recognized fund family in the financial industry. Its ... Read Full Answer >>
  6. Which mutual funds made money in 2008?

    Out of the 2,800 mutual funds that Morningstar, Inc., the leading provider of independent investment research in North America, ... Read Full Answer >>
Related Articles
  1. Stock Analysis

    GE Vs. Honeywell International: Which is Better for My Portfolio in 2016? (GE, HON)

    Learn which stock is the best investment, General Electric or Honeywell. Discover which of the two stocks is preferred by asset managers.
  2. Mutual Funds & ETFs

    Top 4 Royce Funds for Retirement Diversification in 2016

    Discover four of The Royce Funds mutual funds suitable for diversifying retirement portfolios that focus on investing in small-cap companies.
  3. Mutual Funds & ETFs

    Top 3 VALIC Funds for Retirement Diversification in 2016

    Learn about the VALIC fund family, its performance relative to its peers and the top three VALIC funds to consider for retirement diversification in 2016.
  4. Investing News

    Should You Be Betting with Buffett Right Now?

    Following Warren Buffett's stock picks has historically been a good strategy. Is considering his biggest holdings in 2016 a good idea?
  5. Chart Advisor

    ChartAdvisor for February 12 2016 (SPY, DIA)

    A weekly technical summary of the major U.S. indexes.
  6. Mutual Funds & ETFs

    The 4 Best T. Rowe Price Funds for Growth Investors in 2016 (TROW)

    Discover the four best mutual funds administered and managed by T. Rowe Price that specialize in investing in stocks of growth companies.
  7. Mutual Funds & ETFs

    The 3 Best T. Rowe Price Funds for Value Investors in 2016

    Read analyses of the top three T. Rowe Price value funds open to new investors, and learn about their investment objectives and historical performances.
  8. Mutual Funds & ETFs

    Top 3 Lazard Funds for Retirement Diversification in 2016

    Learn about Lazard Asset Management, its long history of strong performance and the top three Lazard funds to consider for retirement diversification.
  9. Investing News

    Today's Sell-off: Are We in a Margin Liquidation?

    If we're in market liquidation, is it good news or bad news? That party depends on your timeframe.
  10. Investing Basics

    How liquid are Fidelity mutual funds?

    Review the liquidity features of mutual fund shares and an overview of Fidelity mutual funds. Most investors look for convenient access to their investments.
RELATED TERMS
  1. Green Fund

    A mutual fund or other investment vehicle that will only invest ...
  2. Alternative Energy ETF

    An exchange-traded fund that invests in companies engaged in ...
  3. Warrant

    A derivative that confers the right, but not the obligation, ...
  4. Bull Call Spread

    An options strategy that involves purchasing call options at ...
  5. Board Of Directors - B Of D

    A group of individuals that are elected as, or elected to act ...
  6. Consumer Staples

    Essential products such as food, beverages, tobacco and household ...
Hot Definitions
  1. Harry Potter Stock Index

    A collection of stocks from companies related to the "Harry Potter" series franchise. Created by StockPickr, this index seeks ...
  2. Liquidation Margin

    Liquidation margin refers to the value of all of the equity positions in a margin account. If an investor or trader holds ...
  3. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  4. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  5. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
Trading Center