Understanding Stock Market Indices

What is a Stock Market Index?

Stock market indices are portfolios that measure the overall market status or observe the performance of specific sectors. They can include a specific subset of stocks or those operating within certain sectors. The value of the index increases or decreases according to the performance of the included stocks, providing insight into the overall market or sector situation. For investors, indices serve as benchmarks for comparing their performance.

How is a Market Index Created?

Stock market indices can be general or sector-specific. For example, the Dow Jones Industrial Average (Dow 30) consists of stocks from 30 large American companies across various sectors such as industry, technology, finance, and healthcare. Conversely, the Nasdaq 100 Technology Sector Index includes the largest 100 American technology companies. While both indices indicate the status of the US market, the Nasdaq 100 specifically shows the performance of the technology sector.

Indices can also be local or global. For example, the S&P 500 represents the largest 500 companies trading on US exchanges, while the MSCI World Index covers approximately 1,600 companies from 23 developed countries. The S&P 500 allows for observation of the US market's performance, whereas the MSCI World Index shows the performance of companies in developed markets.

How are Index Values Calculated?

Each index is calculated using its own unique formula. Commonly used calculation methods are:

• Market-Cap Weighted: In this method, the weight of each stock in the index is determined proportionally to its market value (the number of shares in circulation multiplied by the price of the stock). In indices calculated by this method, large companies have a greater impact on the index's performance. Examples include the S&P 500, Nasdaq 100, DAX 40, FTSE 100, France 40, Hang Seng, Russell 2000, IBEX 35, and SMI 20.

• Price Weighted: In this method, the weight of the stocks in the index depends on the stock price. Therefore, in indices using this method, high-priced stocks have a greater influence on the index's performance. The Dow 30 and Japan 225 are examples of price-weighted indices.

• Equal Weighted: In indices calculated by this method, all stocks have equal weight. Thus, large companies do not dominate the index's impact, and relatively smaller companies can also affect the index's performance. Examples include the S&P 500 Equal Weighted Index, NASDAQ-100 Equal Weighted Index, Dow Jones U.S. Equal Weighted Total Stock Market Index, and FTSE 100 Equal Weighted Index.

Conclusion

Indices provide significant information about the general condition of local or global markets or the performance of specific sectors. Stock market indices play an essential role in financial markets as they guide market participants, allow observation of market trends, aid in the development of trading strategies, and offer portfolio diversification opportunities.