Stock indexes are something most of us have heard of, but we don't really know much about them. This article will explain what stock indexes are and how they work.
What is an index of stocks?
A stock index is just the average price of a large group of stocks, such as all the stocks on a certain stock exchange or all the stocks in a certain investing sector. Indexes are made up of stocks that have something in common, like being on the same exchange, coming from the same industry, or being the same size or located in the same place. Stock indexes show us how the economy is doing in a certain industry or exchange as a whole.
There are many stock indexes. In the US, the Dow Jones Industrial Average, the New York Stock Exchange Composite Index, and the Standard & Poor 500 Composite Stock Price Index are the most well-known.
What's the deal?
There are different ways to figure out what an index is. A "price weighted index" is an index that is based only on the prices of stocks. This type of index doesn't take into account how important each stock is or how big the company is.
On the other hand, a "market value weighted" index takes into account how big each company is. So, when a small company changes its prices, it has less of an effect than when a large company does.
The "market share weighted" index is another kind of index. This kind of index is based on the number of shares instead of the total value of those shares.
Index As a Way to Invest
Indexes also serve a very important purpose in that they can be used as investment tools on their own. Mutual funds that are based on an index have the same holdings as the index they are based on. So, if index A goes up by 1%, the Index A Mutual Fund also goes up by 1%. This has the huge benefit of being much cheaper. Plus, studies have shown that these index funds do better than managed funds most of the time.
The Big Ranks
The Dow Jones Industrial Average is one of the most well-known indexes in the world. It is a "price-weighted average" index made up of 30 of the most important companies in the United States. Some people don't think that 30 companies are enough to make an accurate assessment of such an important measurement, but it is reported every day all over the world.
The Standard & Poor 500 Index is made up of 500 US companies that were carefully chosen to show how the economy is doing as a whole.
Outside of the United States, the FTSE 100 Index, which is made up of 100 of the largest companies on the London Stock Exchange, is the most important index. It is one of Europe's most important indexes. The CAC 40 in France and the Nikkei 225 in Japan are also very important.
