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What is Stock Index?
The stock index also referred to as the stock market index is an indicator of how securities of a section are performing. It’s a tool used by financial managers and investors for describing the market condition and compare the return on specific investments. The stock indexes are relatively easier to interpret and indicate live performance increasing their importance around the world.
Indexes are often used as a benchmark against which performances of Mutual Funds and ETF’s are compared. The stock index is further used as investment decisions before adjusting the portfolio. For e.g. a number of Mutual Funds compare their returns to the return in the S&P 500 displaying to the investors how their funds are performing in tandem with the stock index.
List of Top 5 Types of Stock Index
Below is the list of top stock indices –
#1 – Standard & Poor 500 (S&P 500)
S&P 500 is a large and diverse stock index made up of 500 of the most widely traded stocks especially in the USA. Since the USA is an epicenter of the financial activities impacting across the world, this index gives a good indication of movement in the US as a marketplace. The stock index is market weighted (capitalisation weighted), each stock is represented in proportion to its market capitalization. Thus, if the total market value of all 500 companies in the S&P 500 increases by 6%, the value of the index also increases by 6%.
Firms from various sectors are included in this index such as:
- Financial sector
- Information Technology
- Consumer Staples
#2 – NASDAQ
It’s a stock market index of the US which measures the performance of around 3,000 companies including foreign companies. Predominantly, known for technology-based companies such as Google, Apple, and other firms in the growth stages, the NASDAQ also measures stocks from other sectors such as:
The value of NASDAQ is computed on the company’s outstanding stock i.e. market capitalization average of multiple firms part of the index. Therefore the performance of NASDAQ is directly proportional to the performance of the technology sector. There are 3 different market tiers namely:
- Capital market (Small cap): An equity market for firms with small levels of market capitalisation and requirements for listing are less stringent.
- Global Market (Midcap) includes around 1,500 stocks representing Nasdaq global markets and are required to meet strict financial and liquidity requirements. There are certain Corporate Governance Standards which have to be met.
- Global Stock Market (Large Cap) is a market capitalization-weighted index made up of US-based and International stocks. It is required to meet more stringent requirements as compared to the mid-cap and relatively exclusive in comparison to others. The listing department will regularly review the performance and associated rules governing these stocks.
#3 – DJIA (Dow-Jones Industrial Average)
The DJIA is one of the oldest and well-known indices in the world comprising 30 major companies belonging to the industry leaders which significantly contribute to the industry and stock market. The Dow is a price-weighted average stock market index indicating that any type of stock split or adjustment is not considered in the average price computation.
Since it represents a large section of the US market, a percent change in the Dow should not be interpreted as an equal change in the overall market. This is due to the price-weighted function. For e.g., if the value of one stock falls from say $450 to $50, the entire stock market index may fall by around 3,000 points since the quantum of one stock weighs heavily on the base of 30 firms. As the index consists of some of the well-established companies in the US, large swings in the index can generally correspond to the entire market movement, though not necessarily on the same scale.
#4 – FTSE 100 Index (Financial Times Stock Exchange)
Stock index consists of 100 companies listed on the London Stock Exchange with the highest market capitalisation which is maintained by the FTSE Group (the subsidiary of the London Stock Exchange Group). Many of these 100 firms are internationally focussed and hence may not be the best indicator of the UK economy is functioning and are significantly impacted by the exchange rate of the Pound. The FTSE 250 stock market index could be considered since it includes a smaller proportion of international firms.
The share prices are weighted by market capitalization so that larger firms make more difference to the index instead of the smaller ones. The basic Stock Index formula is:
Free float adjustment factor is the percentage of all issued shares readily available for trading. The free float capitalization of a company is calculated using the Market cap (number of shares * share price) and multiplied by the free-float factor. It does not include restricted stocks held by insiders such as ESOP’s.
#5 – Russell Indexes
Stock index is a family of global equity indices from FTSE Russell permitting investors which track the performances of specific market segments. Many mutual funds or ETF fund managers use FTSE Russell as benchmarks for measuring their respective performances. The most established index in the series is Russell 2,000 which exclusively tracks the US small-cap stocks of the Russell 3,000 stocks. The participants of the Russell 3,000 and its subsets are determined every year during the annual reconstitution with quarterly enhancements including any IPO’s. The top 1,000 companies are the large-cap ones and the others are the small-cap stocks.
Stock index has a rule-based and transparent process for forming the index by listing all firms in a descending order by market capitalization adjusted for the float (actual number of shares available for trading).
The stock index has generally used a benchmark around the world to give a quick indication of how the stocks are performing across sectors. The movement also has a widespread impact on other macroeconomic factors such as Political and overall economy as well.
The stock index gives a quick indication of the direction in which the market is moving and also which industry/company is driving the change.
This has been a guide to what is a stock index? Here we discuss the top 5 stock market index including the S&P 500, NASDAQ, DJIA, FTSE 100 and Russel Indexes. You may learn more about stock markets from the following suggested articles –