Which is the best index to use to study the possible future price action of a given small-cap stock?

By Casey Murphy AAA
A:

It is a smart idea to study the movements of a broad-based index of companies before making an investment decision. Specifically, you should look at an index made up of companies whose attributes resemble those of the securities found in your own portfolio. There are many indices and mutual funds that are comprised of small-cap stocks - companies with a market cap between $300 million and $2 billion. Let's look at the two most popular ones.

Standard & Poor's 600 - This index is likely the most popular index used by traders to gauge the direction of any given small-cap stock. It is comprised of 600 small-cap stocks and is generally less volatile than other small-cap indices because of the strict standards that companies must meet in order to be included in the index.

Russell 2000 - This index gives traders a comprehensive picture of the small-cap segment of the U.S. markets. It is composed of the smallest 2,000 companies that make up the broader Russell 3000 - an index developed to gauge the performance of the majority of the companies listed in the U.S. markets. Many traders like using the Russell 2000 because it factors in a larger number of companies than the S&P 600, which means it may provide a more accurate depiction of the future direction of small-cap stocks.

If an investor is familiar with either of these indices, he or she should have a good grasp of the general trend of the majority of U.S-based small-cap stocks. It should be noted that it will become harder to profit from a small-cap stock when the general trend of either of the above indices is down.

To learn more, see Introduction To Small Caps, What Is A Small Cap? and Market Capitalization Defined.

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