Most of us have heard of stock indexes, but have only a fuzzy idea of them at best. This article aims to clarify some of the basics of stock indexes — what they are and how they work.
What Is A Stock Index?
A stock index is simply an average price for a large group of stocks, either those on a particular stock exchange or stocks across an entire investing sector. Indexes are formed from stocks with something in common: they are on the same exchange, from the same industry, or have the same company size or location. Stock indexes give us an overall snapshot of the economic health of a particular industry or exchange.
Many stock indexes exist; in the United States the most well known are: the Dow Jones Industrial Average, the New York Stock Exchange Composite index, and the Standard & Poor 500 Composite Stock Price Index.
How Does It Work?
There are several ways to calculate an index. An index based solely on stock prices is called a “price weighted index.” This type of index ignores the importance of any particular stock or the company size.
A “market value weighted” index, on the other hand, takes into...
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