What are Stock Market Indices

Stock market indices are measurements that track the performance of a group of stocks from a stock market or a sector. They are used to show whether the overall market, or part of it, is going up or down over time.

Key Moments

• Stock market indices help investors follow market performance
• Indices are based on selected groups of companies
• Some indices track the whole market, while others track specific industries
• Investors and analysts use indices to compare market trends and investment performance.

What are the Stock Market Indices

Stock market indices are groups of selected stocks and are used to measure the performance of a market or industry and of course economy. An index combines the prices or values of multiple stocks into one number, that way it is easier to track market changes.

What does Stock Volume Indicate

Stock volume indicates how many shares of a stock are traded during a specific period of time. High trading volume usually shows strong investor activity, while low volume may show weaker interest or less market activity.

Volume is used to measure market participation and can help show how liquid a stock is.

How are Stock Market Indices Calculated

Stock market indices are calculated by combining the values of the stocks included in the index into a single number. The calculation method depends on the rules of the specific index.

1. Price-Weighted Index

A price-weighted index sums up the raw dollar prices of its constituent stocks and divides them by a normalization factor.

Dow Jones Industrial Average (DJIA) and Nikkei 225 indices are calculated using this method

$\mathrm{Index\; Value}=\frac{{\text{Stock Price}}_1+{\text{Stock Price}}_2+\dots +{\text{Stock Price}}_n}{\text{Index Divisor}}$

Let’s say we have 3 stock price-weighted index:

• Stock A: $100
• Stock B: $50
• Stock C: $10
• Initial Divisor: 3

$\mathrm{Initial\; Index\; Value}=\frac{\mathrm{100}+\mathrm{50}+\mathrm{10}}{\text{3}}=\mathrm{53.33}$

If Stock A goes up +$10, the new index is (110+50+10)/3 = 56.66 a 6.2% increase.

If Stock C goes up +$10, the new index is (100+50+20)/3 = 56.66 a 6.2% increase.

The problem with this method is that actual size of the company is completely ignored. A tiny company with a $300 stock price will impact the index 30 times more than a massive multi-trillion dollar empire whose stock trades at $10. And if a company does a stock split, dropping its price from $100 to $50, its influence on the index is instantly cut in half, forcing an immediate backward adjustment to the index divisor to prevent a artificial crash.

2. Market Capitalization Weighted Index

A market cap weighted index weights each company based on its total economic size. Most modern cap-weighted indices use float-adjusted market caps, meaning they only factor in shares actively available to the public.

S&P 500 and Nasdaq Composite are calculated using this method

$\mathrm{Index\; Value}=\frac{\Sigma (Share\; Price\; \times \; Float\; Shares)}{\text{Index Divisor}}$

For example we have 2 stock market cap index:

• Company X: Price $10 × 100M shares = $1 Billion Cap | Weight: 91%
• Company Y: Price $100 × 1M shares = $100 Million Cap | Weight: 9%
• Total Value: $1.1 Billion
• Assumed Divisor: 1,000,000
• Initial Index Value: $1,100,000,000/1,000,000 = 1,100

If Company Y's stock price doubles +100% to $200, the new total cap is 1.2 Billion. The index rises to 1,200, a 9% increase.

If Company X's stock price rises by just 10% to $11 the new total cap is $1.2 Billion. The index also rises to 1,200, a 9% increase.

This structure results in severe concentration risk. Because the largest companies grow to dominate the index, a handful of mega-cap technology stocks can pull the entire index upward (as it is happening right now - big7), hiding the fact that the remaining hundreds of smaller companies in the index might actually be crashing.

3. Equal-Weighted Index

An equal-weighted index treats every single corporate entity exactly the same, whether it is a $3 trillion titan or a $10 billion mid-cap.

$\text{Index Value}=\text{Base Value}\times \frac{1}{n}\Sigma \left(\frac{{\text{Current Price}}_i}{{\text{Base Price}}_i}\right)$

Every company starts with an identical slice of the pie. If an index has 500 companies, every single stock is strictly allocated exactly 0.2% of the index total value.

• If a mega-cap stock like Apple drops 5%, the index takes a tiny hit based on its 0.2% weight.
• If a small utilities company in the index rallies 5%, it boosts the index by the exact same amount because it also possesses a 0.2% weight.

This method demands high maintenance and turnover, because stock prices fluctuate constantly every second, the weights immediately drift away from being equal, so index must undergo an aggressive quarterly rebalancing. This forces funds tracking the index to mechanically sell off their best-performing, winning stocks and buy more shares of their worst-performing, losing stocks to drag the percentages back to equal.

Most Popular Indices

Indices are a great way to track major financial markets around the world. Understanding the trends, even spotting bubbles.

• S&P 500
• Dow Jones Industrial Average
• NASDAQ Composite
• FTSE 100
• Nikkei 225
• DAX

Below, we'll take a detailed look at various indices from around the world. Familiarize yourself with them; the more you know, the better your understanding of the economic system.

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