Price movements in indices reflect the performance of a group of underlying products
What is an index?
An index measures the collective price performance of a group of stocks, usually from a particular country or industry. Indices are often used to track and compare the performance of stock markets.
The performance of each index is dictated by the performance of the underlying stock prices that make up that index. An index is constructed and calculated independently, sometimes by a bank or by a specialist index provider like the FTSE Group. The choice of the companies included in the index is determined by index calculation rules or by a committee. Not all indices use the same rules, however.
DNA of a stock market index
Price weighted indices
The index is calculated by adding together the price of each stock in the index and then dividing by the number of stocks in that index. Higher priced stocks exert more influence on the performance of the index. The Dow Jones Industrial Average is an example of a price weighted index.
Market capitalization weighted indices
The index is calculated by adding up the market capitalization of each stock and then dividing by the number of companies. Larger companies with a higher market cap will exert more influence on the performance of the index. The FTSE 100 is an example.
Composite indices provide a statistical measure of performance in a market or sector over time. They are useful for measuring an investor’s portfolio performance. They may be price weighted or market capitalization weighted. The NASDAQ is an example of a composite index as it measures the performance of an index that is heavily weighted toward technology stocks.
The composition of an index will change from time to time, based on the rules the index calculator has established. Some companies can be given a larger weighting than others. This means they make up more of the index, and their stock price will have more influence over the performance of the index.
Consider for each index:
- Which companies are included: What are the rules for companies to be added or removed?
- How often the index is changed: This is sometimes referred to as rebalancing; some companies will be removed and others added on a periodic basis.
- What area of the market is covered: Not all indices cover the largest stocks, some are calculated to measure the performance of specific segments of the economy.
The price of an index is changing all the time as the prices of the underlying stocks fluctuate.
Benchmark indicesSometimes you will hear journalists and analysts refer to a market’s benchmark index – this is an index most commonly used to track where a particular market is heading. A few of the main ones include:
- The Dow – the Dow Jones Industrial Average, the original stock market index, was created by Charles Dow in 1884. It follows the price of the 30 biggest companies on the New York Stock Exchange.
- Standard & Poor’s 500 (S&P 500) – this is the most widely tracked measure of the US stock market. It tracks the prices of the biggest 500 companies listed on the New York Stock Exchange and the NASDAQ.
- FTSE 100 – launched in 1984, the FTSE tracks the prices of the biggest companies by market capitalization listed on the London Stock Exchange.
- Nikkei 225 – this is the main stock market index for Japan, tracking the shares of 225 companies listed on the Tokyo Stock Exchange.
- EU Stocks 50 – this index was created to follow the prices of the biggest 50 companies in the Eurozone countries.
- DAX – founded in 1988, Germany’s DAX follows the shares of the largest 30 companies listed on the Frankfurt Stock Exchange.
- CAC – tracks the largest 40 companies listed on the Euronext Paris exchange.
- ASX – the benchmark index for the Australian stock market is the ASX 200, which follows the prices of the 200 largest companies listed on the Australian Stock Exchange, ranked by market capitalization.
What moves indices?Indices tend to be affected by broader market moves which affect the price of many companies. Typical examples include:
- Political unrest or uncertainty
- Economic announcements, such as inflation statistics or unemployment numbers
- Changes to interest rates
- Good or bad news affecting several big companies in the same industry
- The performance of the stocks within that index
Start trading indices with FOREX.com
- At FOREX.com we provide a wide range of global indices
- We use our own names for the major indices – for example, we call the FTSE 100 the UK 100, and the DJIA is called Wall Street
- Find out more about our index trading and pricing