What is a stock market index?
It is possible to define a stock index as a mathematical weighting (there are several models for this) of a set of securities that are listed in the same market to measure (in totality) the growth or decrease of the companies (stocks) that it comprises. Instead of gauging the performance of one company, it gauges the performance of many companies at once. For example, the FANG ETFs measure the performance of technology companies Facebook, Amazon, Netflix, and Google.
A more technical explanation states that a stock index is a numerical value that tries to reflect the variations in value or average returns of the values that compose it. On the vast majority of occasions as we said earlier, these securities have common characteristics such as belonging to the same stock market, having a similar stock market capitalization or belonging to the same industry.
If we do a bit of history with respect to the stock indices, we could say that the oldest American index is the famous Dow Jones Industrial Average, simply known as Dow Jones, which was created by Charles Henry Dow in conjunction with the Wall Street Journal to measure the Economic and financial activity of the United States at the end of the 19th century.
Which are the most important in the world today ?:
- FTSE 100 (Great Britain):Bt, Barclays, Diageo, Unilever,
- DAX 30 (Germany):BMW, E.On, Bayer, Siemenes,
- CAC 40 (France):L’Oreal, Peugeot, Ax, Alcatel,
- Ibex 35 (Spain):Inditex, Telefónica, Iberia, Banco Santander,
- Dow Jones (USA): Intel, JP Morgan, At & T,
- Nasdaq 100 (US): Google, Yahoo, Microsoft,
- Bovespa (Brazil)
- Merval (Argentina)
- Nikkei 225 (Japan):Sony, Bank Of Yokohama,
In many cases, as you may have noticed in some of the higher indexes, there is a number that accompanies the name that receives, that number indicates the number of companies that compose it, For example, the Nasdaq 100 is made up of 100 companies, as well as Nikkei 225 by that number of companies.
The number of companies is certainly important, since sometimes if one falls a lot in trading for extended periods of time, when that stock index is updated to reflect the companies that participate in it (usually every 6 months), the outlier and poor performer will be removed from the index and often replaced.
All this seems very complex but it is basically done according to industry and market capitalization. Market capitalization, ie the price that the company is worth in the stock market, is calculated by multiplying the number of shares by the share price. We should point out that normally when we see an index, we see a value in points such as 7,500 and a percentage that indicates its rise or fall. The percentage is always shown depending on the range of time we are comparing and the historical evolution of the index, while the so-called points have a beginning point called the stock market base. The base is a relative value and without importance, but what is important is the evolution of value according to the change in the number of points.
There are usually two ways in which you can weight an index:
- The classical one, which interprets all companies equally, regardless of the value of their shares and the amount of the shares, so it is evaluated by making a weighted average of the percentage of increase or decrease of the shares included in it.
- By market capitalization, where the value of shares and the number of shares comes into play. We wont actually go into the mechanics of calculating this as its routinely already done for you.
An index by market capitalization is much more complex, but also gives greater importance to companies that actually comprise it because they have outsized influence on shaping the value of the overall index.