Stock Indexes: The Inside Story


What is a Stock Index?

Stock Index can be considered as the average of the stock prices of a group of stocks, which can be either stocks of a specific stock exchange or can be the stocks of an entire sector of investment on the whole. The indexes include stocks which have a common aspect among them. The common aspect might either be the same stock exchange they are traded in, the same industry such as banking, real estate or can also be stocks of companies belonging to the same region or have the same size. By having a look at the stock index, one can have a clear idea of the overall performance and health of the common aspect they belong to.

There are several stock indexes present all over the world. Consider the case of United States, which comprises of the Dow Jones Industrial Average, the New York Stock Exchange Composite Index and the Standard & Poor 500 Composite Stock Price Index as an indicator for the stock trading index.

How does the Stock Index work?

Any index can be calculated in several methods. However, there are three major types which can be seen below:

  • When the index is dependent only on the stock price, it is known as “Price Weighted Index”. The drawback of this type is that, the company size or the significance of any particular stock is not taken into consideration.
  • There is another type of index known as the “Market Value Weighted Index” where the size of companies are taken into consideration. Due to this, smaller companies would not have much influence on the index whereas large and stable corporations have a major share in determining the index.
  • The third type of index is the “Market Share Weighted Index”, which takes into consideration the number of shares instead of the total value of the shares.

 Index as an Investment Tool

Indexes serve as an investment instrument of either the underlying stocks or of the investment itself. Consider an index X, which went up by 2% due to active stock trading. This indicates that the mutual fund index of X has also rose by 2%. The main advantage is that they can be achieved at lower costs and still have better benefits than managed funds.

The Big Index

The Dow Jones Industrial Average, a popular index, is a “Price Weighted Average Index” and comprises of 30 stocks of companies that have the most influence on the economy of America. Although some people opine that stock trading of a mere 30 companies are not sufficient to assess the value, it is being used as an indicator worldwide.

A better assessment can be obtained by the Standard & Poor 500 Index as it comprises of stocks of 500 companies and throws more clarity on the economy.

Apart from the indexes of USA, the FTSE 100 Index is popular. It represents stocks of 100 largest companies trading in the London Stock Exchange and is the most crucial indicator for indexes in Europe. Japan’s Nikkei 225 and France’s CAC 40 are also highly popular.