Definition: A stock index, also known as a stock market index, measures the weighted average of the value of selected stocks that follow the index to help investors and traders determine a market’s return on investment.
What Does Stock Index Mean?
Contents
- What Does Stock Index Mean?
- Example
- Summary Definition
What is the definition of stock index? A stock index measures the change in a financial market, and it represents a portfolio of securities trading on a particular market. There are different stock indices, widely followed, such as the S&P 500 index, the Dow Jones Industrial Average index or the Nasdaq Composite index that all measure the changes in different portfolios of securities.
Stock indices track each market depending on how broad the index is and what is the averaging methods used to assign weights on the securities based on their market capitalization or their market price.
Let’s look at an example.
Example
Alex is a financial analyst at Morgan Stanley. He is asked to break down the S&P 500 Index and report how the stock index tracks the different stock in a portfolio. Alex uses a sample of 20 stocks that are tracked by the S&P 500 index and performs an analysis based on market capitalization.
The S&P 500 market cap is about $19.09 trillion, which 70% to 80% of the total US stock market capitalization. By breaking down the S&P 500, Alex concludes that the first 20 companies with the highest weights account for the 33% of the index. Their average market cap is $315.11 billion, with a maximum value of $589.44 billion and a minimum value of $170.08 billion.
Then, Alex is asked to break down the Dow Jones Industrial Average index, which a price-weighted index and allocates weights based on the stock prices. Alex uses a sample of 20 stocks that are tracked by the Dow Jones Industrial Average index and performs an analysis based on the stock price. By breaking down the Dow Jones Industrial Average index, Alex concludes that the first 20 companies with highest prices account for 10.03% of the index.
Therefore, market-cap-weighted indices assign higher weights to largest companies based on their market cap. Price-weighted indices assign larger weights to stocks with the highest prices.
Summary Definition
Define Stock Index: Stock indices are groupings of companies’ stocks designed to help investors track market trends and measure changes in the market.
