An index is a measure of an economy or securities market, that encompasses the value or performance of several companies. For example, the DAX30 Index consists of 30 major Germany companies traded on the Frankfurt exchange.
Most Indices use Market Capitalization Weighting, meaning that the more share value a stock has, the more weight it is given in the calculation of the overall index.
For instance, if a company’s market capitalization is $1 m and the market capitalization of all stocks in the index is $100m, then this particular company would contribute 1% to the total index.
BREAKING DOWN 'Index'
Each index related to the stock and bond markets has its own calculation methodology. In most cases, the relative change of an index is more important than the actual numeric value representing the index. For example, if the Financial Times Stock Exchange (FTSE) 100 is at 6,670.40, that number tells investors the index is nearly seven times its base level of 1,000.
However, to assess how the index has changed from the previous day, investors must look at the amount the index has fallen, often expressed as a percentage.
Relationship Between Trading Indices, Mutual Funds and Exchange-Traded Funds
When putting together mutual funds and exchange-traded funds (ETFs), fund sponsors attempt to create portfolios mirroring the components of a certain index.
This allows an investor to buy a security likely to rise and fall in tandem with the stock market as a whole or with a segment of the market.
Examples of Trading Indices
The Standard & Poor's 500 is one of the world's best known indices and one of the most commonly used benchmarks for the stock market.
It includes 70% of the total stocks traded in the United States. Conversely, the Dow Jones Industrial Average (DJIA) is also a very well-known index, but it only represents stock values from 30 of the nation's publicly traded companies.