Index stock
Family I · Instruments
Not to be confused with index, limit stock order, index cfd.
Index stock is a share of a company that belongs to a market index, such as the S&P 500 or FTSE 100. Its price is one of the inputs used to calculate the index level, so its movements affect the index value. Inclusion in an index is determined by the index provider's rules and can change over time.
Inclusion and weighting
A stock becomes an index constituent when it meets criteria set by the index provider, such as market capitalisation, liquidity, and free-float. Each index has its own methodology. Weighting schemes vary: some indices weight by market capitalisation, others by price, equal weight, or other factors. The weight of an index stock determines how much its price change influences the index level.
Worked example
Consider a simple price-weighted index of three stocks. Stock A trades at $100, Stock B at $50, and Stock C at $25. The index is the sum of prices divided by a divisor, initially 3, giving an index level of (100+50+25)/3 = 58.33. If Stock A rises to $110, the new index level is (110+50+25)/3 = 61.67, a gain of 5.72%.
Practical considerations
Index stocks are often held by index funds and exchange-traded funds that aim to replicate the performance of the index. Changes to index composition, such as additions or deletions, can lead to trading activity as funds adjust their holdings. The specific rules for index membership and weighting are set by the index provider and may differ across indices and regions.
Often confused with
- index
- An index is a statistical measure of a group of stocks, while an index stock is an individual share that is part of that group; the index is the aggregate number, the stock is the tradable security.
- limit stock order
- A limit stock order is an instruction to buy or sell a stock at a specified price or better, whereas an index stock is a type of stock defined by its membership in an index; the former is a trading instruction, the latter is a security classification.
- index cfd
- An index CFD is a contract for difference whose underlying reference is a stock market index, such as the S&P 500 or FTSE 100, and which settles in cash for the difference between the opening and closing prices without any exchange of the underlying basket of shares.