In our everyday life we often hear information on stock indexes. There is no person who hasn’t heard about the Dow Jones Index but there are not that many people who completely understand what these indexes are about and what it means for you personally.
Becoming an investor is a long way, and there are many schools and methods of predicting and evaluating the market. Stock Market Indexes are essential on your way. However, there are thousands of indexes from major stock market indexes such as Dow Jones to Samurai Bond Market, and you always have a wide range of choices of which one you want to look at. Below there is a stock market index explained, so stick with us here.
What is a Stock Market Index?
Let’s start with the stock market index definition. To put it simply, there is a wide range of companies in industries of all kinds. Each index collects performance data from these companies to build a whole picture that would help investors evaluate and compare ongoing prices with previous ones. So, the definition of a stock index is an index that measures a stock market performance. Later in the article, we will talk a little bit more about different stock indexes that fall within the given stock index definition. But, if you’re interested in, let's say, technology, you should definitely check the Nasdaq index that evaluates this particular field.
Types of Stock Market Indexes
What are the different stock indexes, and which of them can categorize under stock market indexes definition? There are various ways to classify different indexes: by weight, coverage, and ethical investing factors. For example, coverage indexes are extremely useful when we talk about a certain country or region. One of the most famous indexes in the world is the S&P 500, which tracks the performance of the 500 largest companies in the US.
What are the major stock indexes? Four of the most popular ones:
Dow Jones Industrial Average (DJI)
What it is: The Dow Jones Industrial Average is a price-weighted measurement index of the 30 most notable companies, such as Coca-Cola, Disney, Walmart, McDonald's, and Boeing. Since 1896 the list of companies has changed 55 times.
Interesting Fact: General Electric was present in the list from 1896 up to 2018, when it was outrun by pharmaceutical and IT companies.
How it works: In the case of DJI, all the companies within it are categorized depending on the share price. The higher rate means a higher weight in the index. The sum of the component stock is divided by advisor, and the greater magnitude of index movements relied on the most expensive stocks.
Why it matters: We hear about the Dow Jones index on a regular basis on the news, and it is considered one of the main tools for investors. However, there is some criticism that comes from the fact that companies in the list are assigned based on their stock price, which is called a price-weighted measurement model. Other stock market indexes are weighted using the market capitalization model.
What it is: The Nasdaq Index is the second most popular index of stocks, which includes not only ordinary shares but also real estate trusts and American depositary receipts. The difference between Nasdaq and Dow Jones is that Nasdaq is market-capitalization weighted and includes not only 30 but more than 2500 stocks.
How it works: Index movements are defined by the total value of share weights of all the stocks within it, divided by their closing prices for a particular period of time. So, the performance depends solely on closing share prices.
Why it matters: The composition of the index is also more diverse: mostly tech companies but also services and finances. All stock market indexes are valuable for investors not just because they give an idea of today's market but also help to understand the main trends: which industries are becoming leaders and are the most profitable in certain regions or countries.
S&P 500 (INX)
What it is: The S&P 500 also has its roots in the American history of the 19th century, just like the Dow, when the “Investors’ Guide to Railroad History” was published by Henry Poor in 1860. At the beginning of the 20th century, it transformed into a Standard Statistics Company, which rated mortgage bonds and developed a stock market index that included 233 US companies. So the idea of evaluating not only one company but a certain field is not that new.
How it works: This index tracks the market capitalization of the companies within it. Capitalization is measured by multiplying the number of shares by their prices. So, this way, the market performance depends on the changes in the capitalization of the biggest players on it.
Why it matters: Today, the stock market index includes 500 large companies from the large-cap sector. This index is perceived as very representative because it includes companies from all sectors of the economy.
- S&P 500 Growth Index is one more index worth mentioning. It represents the fast-growing companies from the S&P 500. It’s not hard to guess which industry would be largely represented in this index — IT and AI sectors now significantly outweigh other industries.
- S&P MidCap 400 is also distinct from the S&P 500 index, worth watching for every investor who is thinking about investing in middle-size companies. This index measures the performance of 400 companies to evaluate the return characteristics of this field.
Russell 2000 (RUT)
What is it: Russell 2000 is an index for investors who believe the future belongs to small-cap companies. If you’re one of them, this is definitely the index for you to watch. Again, the focus lies on the US market, and it’s mostly used as a benchmark for small-cap stocks.
How it works: This index is market cap-weighted. The stock’s list sale price is multiplied by the number of shares that can be traded. Unlike the other market capitalization-based indexes, Russell 2000 focuses on smaller market players instead of the largest ones.
Why it matters: This stock market index may bring an understanding of the particular field of the market. If you’re not an experienced investor, it is important to remember that all the indexes are valuable. Still, you shouldn’t forget about other factors that influence the performance of companies on the market, such as the economic cycle and others.
Some indexes are not that obvious, but they may come in handy if you’re interested in some specific markets. Let’s start with the hottest topic.
The S&P Cryptocurrency Broad Digital Market Index tracks the performance of digital assets that meet the criteria of minimum liquidity. Cryptocurrency opened a whole new universe in the investment world, and it was supposed to be somehow measured in traditional ways, which is what this index does.
One more essential thing is that the indexes are grouped not only by industry or market capitalization rate. There are indexes based on social factors, sectors, or values.
For example, the JUST US Large Cap Diversified Index (JULCD) is an important index that tracks the performance of companies that have high ESG scores. Over half of them are included in the Russel 2000 index. This score is high in companies that are known for their employee benefits, outstanding atmosphere, and strong commitment to keeping the company culture on a high level. So, if you want to support reliable employers and work ethics, this is a good index to watch.
What is a Stock Market Index's Importance for Me as an Individual Investor
One of the main questions from beginners is, “what is a stock market index's importance for me as an individual investor?”
- To understand the condition of the market: the one that is described in the index, certain industry, or country. However, it’s important to remember that indexes do not represent the whole market but only a part of it.
- Indexes are good in terms of learning the historical background of an industry and watching how it behaved during different parts of the economic cycle and times, such as financial crises. This is not a representative forecasting tool.
- There are not that many investors that need to watch these indexes closely on an everyday basis, unless it’s your full-time job. Indexes show the main trends and patterns, not something that can influence you every day.
There is a comparison to explain the stock market index. Indexes are the universal language among business people from all over the world. People use it to compare, benchmark, and evaluate over time. You may also want to check the list of top industrial stocks and apply your new knowledge to make a good investment decision.
How to Read Stock Market Indexes
Now, let’s check on how to actually read different stock market indexes based on two examples:
Look at the weightage of the indexes
That’s the most common case, in which the first priority is given to stocks with the largest weight.
For one, in the case of market-capitalization-weighted indexes, company A has in total of 10,000 shares, priced at $10 each. It means that the market capitalization of company A is $100,000. At the same time, company B has 3,000 shares, priced at $100 each, and its market cap equals $300,000, while company C has 2,000 shares priced at $500 and owns a cap of $1,000,000. In this example, company B has a higher market cap value than company A, but company C has a higher value than the two other companies combined and will consequentially have a higher impact on the magnitude of the index movements.
In the case of equal-weighted indexes, the weight is distributed between all the companies included, and share prices define the index performance. For example, if the companies A, B, and C have shares prices set at $10, $100, and $500 accordingly, then based on the formula ($10 x 33.3%) + ($100 x 33.3%) + ($500 x 33.3%), the index value would be $203.13.
In price-weighted indexes, the only measure is the value of shares. For example, if companies A, B, and C have share prices set at $10, $100, and $500 accordingly, then according to the formula $10/$100/$500 / ($10 + $100 + $500), the weightage of companies will equal 2%, 16%, and 82% accordingly.
Note the change in value over time
In this case, the value of the stock market index largely depends on the value of individual stocks comprising it. The determinator here is the percentage of the increase or decrease in the value of individual stocks. For example, stock A may start on the new market day at the value of 300 points and go up by 100 points. At the same time, stock B start at 1000 points and go up by 200 points. It may seem that the second stock performed better in terms of value increase, but actually, the first stock showed a higher percentage of profit rise.
For beginners and conservative investors, stock index ETFs are a good start and a decent long-term investment idea. For the general audience, following the main indexes is useful as it helps to be informed about the current market situation. Also, comparing your portfolio growth with an index helps assess the performance and improve your strategy. This function is available in the stock app for beginners — the Gainy app.
What does it mean to invest in an index?
It’s not possible to buy shares in the Dow Jones Index but there are funds that hold all 30 shares of the companies in the proportion of its presence in the DJIA, which may be a good strategy for beginning investors. Also, you can buy an Exchange-Traded Fund (ETF) based on practically any stock or bond index. For beginners and conservative investors these funds are a good start and decent long-term investment idea.
How to read stock indexes?
Depending on the methods chosen, you may guide your estimation based on the weightage of indices or on their values. In the first case, you should look for the impact of changes in the market capitalization of the companies owning stocks, in the second one, evaluate the increase or decrease in the value of stocks on the market.
Do I need to watch all the main indexes?
There is no need to watch all the indexes but it’s important to know main trends and to know the historical context of the market of your choice.
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