What are Stock Indices

A stock index is a market constructed from a selection of stocks which are:

―     listed on an exchange

―     located in a specific geographic region

―     operating in a specific sector

An index is referred to as a ‘basket’ of stocks which measures the collective performance of the stocks it contains. Stock indices provide traders and investors with a quick and useful gauge as to the health and performance of an exchange, region or sector.

Some well-known indices you may have heard of include:

1.      DJIA (Dow Jones Industrial Average): made up of 30 of the largest companies trading on the NYSE (New York Stock Exchange)

2.      FTSE 100: tracks the largest companies (by market capitalisation) on the London Stock Exchange

3.      DAX: tracks the 30 largest companies listed on the Frankfurt Stock Exchange

4.      Nikkei 225: composed of 225 companies on the Tokyo Stock Exchange

5.      S&P 500 (Standard & Poor’s 500): composed of the largest 500 companies on the NASDAQ and NYSE

How are stock indices calculated?

Most indices are calculated using one of two methods:

1. Capitalisation-weighted system

In this method, the greater the market capitalisation of a company, the greater the influence of its share price on the index. Market capitalisation (number of shares issued x share price) is a measure of company size.

2. Price-weighted system

This method gives greater weight to the share price of a company: the higher the share price, the greater the influence on the index.