What is a stock index?

STOCK INDEX.

The stock index function as an indicator of the general economic scenario of a country / region / sector.  If the stock market indices are growing, it indicates that the overall general economy of the country is stable and that the investors have faith in the growth story of the economy. If, however, there is a plunge in the stock market index over a period of time , it indicates that the economy of the country is in troubled waters. It’a also an indication of what the corporates in that country are facing.

A stock index is created by selecting a group of high performing stocks .  For example – The FTSE 100 ( the stock index of London stock exchange) is constructed from the top 100 companies trading in the London stock exchange. If the FTSE 100 records a jump over a period of time, it indicates that most of the top 100 companies in England are doing well at that point of time and that the investors are positive about putting their money in England.

TYPES OF INDICES

There are different types of indices and FTSE 100 was just an example. Stock indices can be constructed -

  • For the entire world ( global indices)
  • For an entire continent ( regional indices – for example S&P Latin america 40)
  • For an entire country  ( national indices – for example Sensex &  Nifty for India )
  • For a particular sector in a country – ( sectoral indices – for example BSE BANKEX which tracks top banking companies in India)
  • For any other theme / group of economy / companies you want to track. ( example Dow Jones Islamic world market index)

The MSCI global and the S & P Global 100 are examples of world stock indices which tracks the largest companies in the world irrespective of their country of origin . The MSCI  global id an index with over 6000 stocks included from different parts of the developed world. It specifically excludes companies from emerging economies.

When stock indices are constructed to track the performance of the economy of a country ( like Sensex in India), it called a national index.

Irrespective of the type of index, the purpose of any index is the same. It provides to the public, a quick view of how the economy ( based on which the index is constructed) is functioning. A sudden slide in indices denotes that the investors have lost faith . There could be several reasons for that like  poor  economic reforms , high inflation, high borrowing costs, amendments in laws that not well received by the business community, downgrades by world credit rating agencies, scams , corruption ..  the list is end less.

These indices also serve as benchmarks for measuring performance of fund managers or for measuring the performance of an individual’s stock portfolio.

CONSTRUCTION OF STOCK INDEX

A stock index can be calculated in two ways -

  • By considering the price of the component stocks alone. This method is called the price-weighted method.
  • By considering the market value or size of the company – called the capitalization weighted method.

To conclude, stock indices are barometers to measure general economic performance of an particular country / sector. It’s updated every second throughout on every trading so as to reflect the exact picture of the economy. It’s also a permanent record of the history of markets – it’s highs and lows, booms and crashes.

You may like these posts:

  1. Stock markets in india

7 Responses to “What is a stock index?”

Hayle

September 21, 2011 at 7:47 pm

I’m impressed by your writing.

aju m james

February 14, 2012 at 3:39 pm

your writing helped me a lot

sangeeta

February 17, 2013 at 9:02 pm

helped in my project…… thanx

Shiva

April 3, 2013 at 9:29 am

Hi,
Above details helped me a lot in understanding basics about an index. Could you please help me get more idea on contituents of an index? How they select and how weights are allocated to them?
Also on decomposition of an index

virender

February 6, 2014 at 3:43 pm

thanks a lot. actually i am keen to get this knowledge and i got it from here with full examples. The examples are helping a lot to understand the concepts.
thanks for all this.

Cindy

May 9, 2014 at 9:32 pm

Amazing articles. Very straightforward and clear! thanks a lot

Rajbeer

November 23, 2015 at 12:32 am

It really help me a lot .
Thank you

Leave a Comment