Stock Market Index 101

Stock Market Index 101

Stock market index or stock index measures the change in the share prices of different companies. It measures a section of the stock market. It is determined by computing the prices of specific stocks (weighted average). Financial institutions and investors widely used this tool to compare the return on certain investments and to describe the market. A lot of mutual funds and exchange-traded funds (ETFs) try to track these indexes to give investors exposure to a given market.

Stock Market Indices Types

There are different ways a stock market can be classified. These are:

  • “World” or “Global” Stock
  • National Index
  • Specialized Indices

“World” or “Global” stock market index contains stocks from multiple regions. It tracks equities from all around the world. Examples of global stocks are MSCI World of S&P Global 100. Regions can be categorized into geographic (Asia or Europe) or industrialization or levels of income (developed markets, frontier markets etc.)

National Index portrays the performance of the stock market of a certain country and shows the sentiment of the investors on the state of its economy. Stocks of large companies listed on the country’s largest stock exchanges are included in the national indices. It offers exposure to individual countries. A lot of indices are regional such as FTSE Developed Asia Pacific Index or the FTSE Developed Europe Index.

Specialized indices track the performance of certain sectors of the stock market. Specialized indices in the United States includes Morgan Stanley Biotech Index which has 36 American companies in the biotechnology industry and Wilshire US Reit in which tracks more than 80 U.S. real estate investment trusts. Organizations of certain size or type of management may be monitored by other indices.

Importance of Indices

Daily results of stock market indices are the most popular and important numbers in the world of investing and finance. The Dow Jones Industrial Average (DJIA) in which comprises 30 largest traded companies in the U.S. is probably the world’s most famous and most widely used stock market index.

Managing investment portfolios and following the financial markets are the reasons why many investors use market indices. Indexes are seriously blended into the investment management business. The funds use indices as benchmarks for comparisons of performance. Investors can also leverage these indices to increase exposure to international stock markets using exchange-traded funds or mutual funds linked to these indices.

Indices Use as Benchmarks

Indexes are used as benchmarks for different goals in the financial markets. Dow Jones Industrial Average, S&P 500 and Nasdaq Composite are the three famous U.S. indexes. Dow Jones Industrial Average has 30 largest stocks by market capitalization in the U.S., 500 largest stocks in S&P 500 and all the stocks are on the Nasdaq Exchange. Since they contain some of the most valuable U.S. stocks, benchmarks can be a good indicator of the gross U.S. stock market.

Performance and benchmarks values can also be used by the investors to observe investments by section.  Based on the returns or expected returns of a specific section, some investors may vary their investment portfolios. Additionally, a specific index can act as a benchmark for a portfolio or a mutual fund.

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