Stock index

DEFINITION of stock index

A stock index is a group of shares that are used to give an indication of a sector, exchange or economy.

WHAT IT IS IN ESSENCE

Usually, a stock index consists of a set number of the top shares from a given exchange.

Some well-known stock indices are

  • The Dow Jones Industrial Average, the top 30 companies on the New York Stock Exchange and NASDAQ
  • The FTSE 100, the 100 biggest companies on the London Stock Exchange by market cap
  • The DAX, 30 major German companies on the Frankfurt Stock Exchange.

As a tracker of several stocks, a stock index itself does not have any inherent value. The index is moving in points and reflects the stock prices of all of its underlying assets. Some stock indices give equal weight to all the stocks they contain, but some give larger importance to larger stocks.

HOW TO USE

To trade a stock index, traders have to use a tracking fund or a derivative like a spread bet, CFD, future or ETF. These products all offer different methods of trading on the price movements of stock indices without having to buy multiple stocks at once.

It is calculated from the prices of selected shares, typically a weighted average.

Financial managers and investors use this to describe the market. And also to compare how well specific investments are doing, such as mutual funds and share portfolios.

You can see index as a ‘basket’ of shares that represent a broad sample of a specific industry, sector or economy. The overall performance of these shares provides a good indication of trends in the market they represent.

The criteria of stock selection could be the type of industry, market capitalization or the size of the company. The value of the stock market index is computed using values of the underlying stocks. Any change taking place in the underlying stock prices impact the overall value of the index. If the prices of most of the underlying securities rise, then the index will rise and vice-versa.

In this way, a stock index reflects overall market sentiment and direction of price movements of products in the financial, commodities or any other markets.