The Different Types of Stock Indexes

The statistical average of a particular stock exchange or sector is called a stock index. Indexes are composed of stocks that are either parts of the same exchange, the same industry or the same companies. The most common stock indexes in the United States are the Dow Jones Industrial Average, the NYSE Composite index, and the S&P 500 Composite Stock Price Index. Stock indexes are used to give an overall perspective of the economic health of a certain industry or stock exchange.

There are different ways to calculate the indexes of stocks. Price weighted index, which is based solely on the price of stocks, does not take into consideration the importance of any particular stock or the size of any company. The index that takes into account the size of the companies is called market value weighted. The fact that the price shifts of small companies have less influence than those of larger companies is considered in this type of index. Another type of index, which is based on the number of shares rather than the total value, is called the market-share weighted index.

Indexes, aside from giving overall grades to particular economies, can also be used as investment instruments. Mutual funds which are based on indexes are called passively managed mutual funds. Managed funds are shown to be consistently outperformed by these kinds of funds. A mutual fund that is based on an index simply duplicated the holdings where the index is based on. So if there is a 1% rise in Dow Jones, the fund based on Dow Jones also experiences a 1% rise. This causes a lower cost advantage for transactions and researches because the savings can be passed on to the participating investor.

The Big Indexes

One of the best-known indexes in the United States is the Dow Jones Industrial Average. It follows the stock movements of 30 of the most influential companies in the country that includes General Electric (GE), Coca Cola, and General Motors. Because it gives more influence to more expensive stocks, it is considered to be a price-weighted average index. A lot of analysts say that price-weighting doesn’t really give an accurate picture of the different stock market movements and that the 30 companies are not enough to form an accurate assessment.

The S&P 500 Index, on the other hand, is based on 500 US corporations that are carefully chosen to represent a broad slice of the country’s economic activity. Although it is only second to the Dow Jones, it is felt to be an accurate predictor of the state and condition of the US economy. The most influential index outside of the United States is the FTSE 100 Index which is based on the 100 largest companies listed on the London Stock Exchange. Beside from being one of the largest indexes in Europe, it also serves as an indicator of the British economy. The other important non-US indexes are France’s CAC 40 and Japan’s Nikkei 225.