Module 1: Stock indices · Lesson 1 of 6
What a stock index is
3 min read
A stock index is a single number that tracks the combined performance of a selected group of company shares, giving a quick snapshot of how a market or sector is doing. How that number is calculated depends on how the index weights each company.
Well-known indices
| Index | Market | Weighting |
|---|---|---|
| S&P 500 | 500 large US companies | Market cap |
| Nasdaq 100 | 100 large non-financial Nasdaq-listed firms | Market cap (modified) |
| Dow Jones Industrial Average | 30 large US companies | Price |
| DAX | 40 large German companies | Market cap |
| FTSE 100 | 100 large UK-listed companies | Market cap |
| Nikkei 225 | 225 large Japanese companies | Price |
Market-cap weighting
Market capitalisation is a company's share price multiplied by the number of shares in issue: in other words, what the whole company is worth on the stock market. In a market-cap-weighted index, bigger companies have more influence. Most major indices use this method, often counting only shares freely available to trade.
Price weighting
In a price-weighted index, companies with a higher share price carry more weight, regardless of how big the company actually is. The Dow and the Nikkei 225 work this way.
Example: Imagine a tiny index of two companies. Company A has a share price of 200 dollars and 1 million shares (worth 200 million dollars). Company B has a share price of 20 dollars and 50 million shares (worth 1 billion dollars). In a price-weighted index, A has ten times B's influence because its price is ten times higher. In a market-cap-weighted index, B has five times A's influence because the company is worth five times as much. Figures are illustrative.
Why this matters to traders
- A big move in one heavyweight company can drag a whole index up or down.
- Two indices covering the same country can behave differently because of their make-up and weighting.
- Technology-heavy indices such as the Nasdaq 100 often react more strongly to interest rate news than broader ones.
Index providers review their members regularly, adding and removing companies, so an index's make-up changes over time.
Key takeaways
- A stock index tracks the combined value of a group of shares.
- Market-cap-weighted indices give more influence to larger companies.
- Price-weighted indices, such as the Dow and Nikkei 225, give more influence to higher-priced shares.
- An index's weighting and members shape how it behaves.
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