What are Stock Market Indices

What are Stock Market Indices

Stock market indices are indicators of the dynamical state of the security market. By comparing current market index value to its previous values it is possible to estimate the market behavior, its reaction to macroeconomic changes and corporate events (mergers, acquisitions, etc.).

The stock index is calculated on the basis of prices of a certain group of securities (index basket). The initial value of the index may be the sum of the prices or be equated to a random number (for example, 1000). The prices are often multiplied by special coefficients. The index price change over time is more important that its absolute value.

Depending on the index basket components, the index can characterize a market as a whole, a market of a certain kind of securities, industry market (for example, telecommunications, transport and more). Comparing the dynamics of various indices, we can give a comparative assessment of the development of various economic sectors. Stock market indices are more often calculated and published by news or rating agencies and stock exchanges. The name of the index often contains the number of securities included in the index (for instance, S&P 500, FTSE 100).

Financial Market Indexes

Stock market indices are also a basis for derivative instruments, such as futures and options, which are used for investment and speculative purposes, as well as for hedging to reduce risks. Moreover, the index value is interpreted as the price of this instrument.

There are several methods for calculating a market index; the main of them are methods of weighting by price and weighting by capitalization. The price-weighted index is the sum of all assets included in the index, divided by a coefficient (for example, the Dow Jones Index). The capitalization-weighted or "cap-weighted" index is calculated as a total market value of all assets included in the index, divided by a coefficient (for example, S&P 500). Most of modern stock market indexes are weighted by free-float weighting. The company's capitalization is the total value of securities issued by the company, calculated at the market price. The calculation parameters may change over time due to corporate events of companies and because of changes in the list of the securities, included in the index.

First Stock Market Index

The very first stock market index was developed in 1884 in the United States - Charles Dow began to count the average change in market prices for 11 major industrial companies. Since 1928, the Dow Jones has been calculated for 30 companies.

Most Popular Indices

The most popular indices in the world are the stock indexes of companies traded on the U.S. (DJI, S&P 500, NASDAQ 100) and European (DAX, CAC 40, FTSE 100) Exchanges, as well as the Japanese stock index called NIKKEI 225. Besides the main index, each of these stock market indexes has an index group differing by composition, economic sector, and other parameters too.