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.
