Stock market index
Family I · Instruments
Not to be confused with index, limit stock order, index cfd.
Stock market index is a statistical measure that tracks the performance of a selected group of stocks, representing a portion of the overall market or a specific sector. It is calculated from the prices of its constituent stocks, often using a weighted average. Indices serve as benchmarks for market performance and are not directly tradable.[1]
Calculation and Weighting
Stock market indices are calculated using various weighting methods. The most common are market-capitalization weighting, price weighting, and equal weighting. In market-cap weighting, each stock's influence is proportional to its market value. Price-weighted indices give higher-priced stocks more weight. Equal-weighted indices assign the same weight to each component.
For example, a market-cap-weighted index sums the market capitalizations of its components and divides by a divisor to scale the index to a convenient number. The divisor is adjusted for corporate actions like stock splits to maintain continuity.
Worked Example
Consider a simple price-weighted index of three stocks: A, B, and C, with prices $100, $50, and $150 respectively. The index is calculated by summing the prices and dividing by a divisor, initially 3.
If stock A splits 2-for-1, its price becomes $50. To keep the index at 100, the divisor is adjusted to 2.5: ($50 + $50 + $150) / 2.5 = 100.
Uses and Variations
Indices are used as benchmarks for portfolio performance, as underlyings for index funds and derivatives, and as indicators of market trends. Different providers may use different methodologies, so the same set of stocks can produce different index values. Examples include broad-based indices like the S&P 500 and sector-specific indices like the NASDAQ Biotechnology Index.
Often confused with
- index
- An index is a broader statistical measure of any market or sector, while a stock market index specifically tracks stocks; the visible sign is that a stock market index always comprises equity securities.
- limit stock order
- A limit stock order is an instruction to buy or sell a stock at a specified price or better, whereas a stock market index is a statistical measure; the visible sign is that a limit order is an actionable trade directive, not a calculated value.
- 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.
See also
References
- ↑ Methodology documents of the index providers. An index CFD tracks a provider's index; constituents and weighting follow that provider's published methodology, not the broker.