The price changes in a market or a part of a market are shown in price indices called stock market indices. Such indices are mainly market capitalization (total market value of capital of a company) weighted, the weights reflect the contribution of the stock to it's particular index. The elements that make up the index are reviewed often to include and exclude stocks in order to reflect the ever changing business environment.
The definition of a stock index is a statistical average of a particular stock exchange. An index is basically a group of stocks that have something in common. Perhaps they are all part of the same industry or they represent companies of a certain size or geographic location.
1. Major Stock Indexes
- Dow Jones Industrial Average
- NYSE Composite index
- S&P 500 Composite Stock Price Index
2. Calculating Indexes
A price weighted index is solely based on the price of the stock. It doesn't take into consideration the size of the company. An index that is market value weighted, on the other hand, takes into account the size of the companies. That way, price shifts of small companies have less influence than those of larger companies.
3. Using Stock Indexes To Plan Your Investments
Many choose to invest using the index method. In this method, you holds a portfolio consisting of an entire stock market or some segment of the stock market (such as the S&P 500 or Dow Jones Industrial Average). The main goal of this strategy is to stay diversified and too minimize taxes from trading too frequently. Using Indexing also allows you to ride the trend of the stock market.
If you base your mutual fund on an index, it will generally outperform ones that aren't. Mutual funds based on an index simply duplicate the holdings where the index is based on. Thus if the Dow Jones rises by 1% the fund based on the Dow Jones also rises by the same amount. This has the advantage of lower costs for research and transactions - savings that can be passed onto you!
4. The Major Players
The Dow Jones Industrial Average is based on the top 30 companies in America and is price weighted. The S&P 500 Index is based on 500 United States corporations. It is second in influence after the Dow Jones and is felt to be an accurate predictor of the state of the United States economy. Outside of the United States the most influential index is the FTSE 100 Index.
