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What is a Stock Market Index?

2017-04-01T11:18:19+00:00

The term 'Stock Market Index' is included in the Economics edition of the Financial Dictionary. Get yours now on amazon in ebook or paperback format. Read more here...

A stock market index refers to a collection of stocks which are combined together to create a bellwether for a group of similar companies in the market. The idea is to present an index which tracks a certain sector, market, currency, commodity, bond, or other type of financial asset.

Stocks which are collected in such an index are put into a so-called basket. An example of this is easy to understand. A person who wished to invest in the DJIA Dow Jones Industrial Average index would buy into the shares of the index basket that represented the 30 component companies. This means that the investor would then own 30 different companies’ stock shares.

The idea behind indices is that they track the underlying assets or market. The XAU Gold and Precious Metals Index is comprised of those companies which mine precious metals including gold. Purchasing shares in this index means that an investor has the benefit of exposure to the entire gold mining sector. They achieve this without having to acquire shares in all of the gold mining firms of the globe. It is accomplished because shares in XAU represent all of the gold mining shares in the form of the entire industry.

These indices were fashioned to imitate particular markets. This does not mean they will ever be accurate all of the time nor even 100 percent at any given point. This is because there are a wide range of factors that can change the market course which indices will not always capture with perfection immediately.

Not every stock market index is liquid. This means that it could be hard to get in and out of some index-based positions. It is also the case for some stock company securities too. Because of these problems, there are alternatives to a stock market index. These are called ETF Exchange Traded Funds. Such ETFs have the advantage of being constructed in order to imitate an index. This is done in the same way that indices imitate stock markets and various other assets. The ETF has the advantages of being immediately ready for trade and a pre-arranged package. This makes an ETF a true mini portfolio available for an affordable price with reasonable fees (especially as compared to mutual funds).

There are many stock market indices that are well-known throughout the world. The most famous of these is surely the DJIA Dow Jones Industrial Average. This 30 stock company index trades every day on the NASDAQ and NYSE New York Stock Exchange. The component companies of this most famous of indices on the planet include such internationally respected giants as the Walt Disney Company, General Electric Company, Microsoft Corporation, McDonald’s, and Exxon Mobile Corporation.

Another internationally followed index is the S&P 500. It measures the values of 500 of the large cap stocks of the United States. The NASDAQ Composite index follows the fortunes of fully 4,000 different company stocks as they trade daily. Yet another stock market index often called the total market index is the Wilshire 5000. While somewhat less famous than the other three, this index of indices follows the performance of every publicly traded corporation which is headquartered within the U.S. The four indices mentioned here address the daily progress of the large American companies. A competing index the Russell 2000 follows the performance of an impressive 2,000 smaller corporations of the U.S. markets.

The market index values are called points. This means that if the London FTSE 100 rose 150 points in a single day that the value increased versus the prior day’s close to that point. It means that the total net gains of all the composite companies collectively increased by a net of 150 points.

Indices such as these assist investors by helping them to keep tabs on the health of various industries in which they may have interests or capital invested. If the DJIA continues to drop repeatedly for a period of many weeks or a month, investors could reasonably conclude at least some of the companies within the underlying index have run into serious trouble. This would be a prescient warning to evaluate the portfolio and perhaps liquidate some of the holdings in favor of other ones which were performing better.

The term 'Stock Market Index' is included in the Economics edition of the Financial Dictionary. You can get your copy on amazon in Kindle or Paperback version. See more details here.