A stock index tracks the ups and downs of a chosen group of stocks or other assets. Observing the performance of a market index provides a quick way to see the health of the stock market, guides financial firms in creating index funds and exchange-traded funds (ETFs), and helps you measure the performance of your investments. .
what is a market index?
A market index tracks the performance of a certain group of stocks, bonds, or other investments. These investments are often grouped around a particular industry, such as technology stocks, or even the stock market in general, such as the S&P 500, Dow Jones Industrial Average (DJIA), or Nasdaq.
There is no set size when it comes to market indices. the djia contains only 30 shares, while the crsp index has more than 3,700. the important thing is that each one contains a sample size large enough to represent the general behavior of the economic portion they claim to represent.
how stock indices are built
Each stock index uses its own proprietary formula to determine which companies or other investments to include.
Indices that measure the performance of broad swaths of the market may only include companies that rank highly in terms of market capitalization or the total value of all their outstanding shares. alternatively, they can be selected by a committee of experts or simply represent all the shares listed on a given stock exchange.
Once an index administrator has determined which companies to include, it must determine how those companies are represented in the index, a factor called the index weight. Depending on the weighting, all companies included in an index can have the same impact on the performance of the index or a different impact depending on market capitalization or share value.
The three most common index weighting models are:
- Market Capitalization Weighted: In a market capitalization weighted index, the index represents more stocks with higher market capitalizations. with this structure, large companies have a greater impact on index performance.
- Equal Weight: With an equal weight index, the index treats all constituents of the index. same way. this means that each company’s performance affects the index by the same amount, whether they are incredibly large or incredibly small companies.
- Price-Weighted: A price-weighted index gives each company a weight difference based on the current price of its shares. companies with higher stock prices have more influence on these indices, regardless of how large or small the companies actually are.
major stock indices
There are thousands of indices in the investment universe. To help you get your bearings, here are the most common indexes you’re likely to come across:
the s&p 500 index
one of the best known indices, the s&p 500 tracks the performance of the top 500 companies in the us. US, as determined by a committee of the s&p dow jones indices. the s&p 500 is a market capitalization weighted index.
dow jones industrial average
the djia has a relatively limited range, tracking performance of only 30 u.s. companies selected by the s&p dow jones indices. Stocks within DJIA come from a variety of industries, from healthcare to technology, but are united by being all blue chip stocks. this means they have a track record of strong financial performance. the djia is one of the few price-weighted market indices.
the nasdaq 100
the nasdaq 100 tracks the performance of 100 of the largest and most traded stocks listed on the nasdaq stock exchange. Companies within the NASDAQ can be in many different industries, but are generally biased towards technology and do not include any members of the financial sector. the nasdaq 100 uses a market capitalization weighting.
the nyse composite index
The NYSE Composite Index is a comprehensive index that tracks the performance of all stocks traded on the New York Stock Exchange (NYSE). the index is a modified market capitalization weighting.
the russell 2000 index
While other stock indices focus on the largest companies in a particular segment, the Russell 2000 measures the performance of 2000 smaller nationally traded companies. the russell 2000 is a market capitalization weighted index.
the wilshire 5000 total market index
The Wilshire 5000 Total Market tracks the performance of the entire US market. stock Exchange. the index is weighted based on market capitalization.
different types of market indices
While the above indices are generally used as indicators of the stock market in general, there are countless other indices, many of which are designed to represent very specific segments of the market.
- environmental, social and governance. the esg indices focus on companies that score well on measures of how they treat the environment, their employees, their management and society in general.
- currency indices. the dollar index is a currency index that measures the strength of the us. uu. dollar relative to a basket of other leading global currencies.
- Global Indices. As the name implies, Global Indices allow you to track the collective performance of all companies of the world .
- National indices. in the same way that the previous major stock indices follow the performance of the us. uu. market, there are indices that track the ups and downs of companies in almost every country.
- growth indices. growth indices track the performance of leading growth stocks, or those stocks of companies that point to faster growth than the market as a whole.
- value indices. value indices, on the other hand, group together companies that investors consider undervalued based on their finances.
- Sector indices. Sector indices are constructed to track the performance of specific industries, such as technology, finance, healthcare, consumer goods, and transportation.
how to invest in stock indices
Because they track the performance of a mix of companies and investments, leading index funds are seen as a great way to invest quickly, easily and cheaply. Index Funds and Exchange Traded Funds (ETFs) provide access to an out-of-the-box diversified portfolio of stocks and bonds and are trusted by many investment gurus like Warren Buffett.
The great thing about index funds and ETFs is that you can invest in them at almost any broker with any amount of money. not sure where to start? Check out our list of the best brokerage firms.
If you’re not sure which investment options are best for you, you can talk to a financial planner, who can help you create a personalized plan based on your goals. or take a look at our ranking of the best index funds.