Stock indices 101: empowering beginners with confidence

Your guide to market benchmarks

You've likely heard of stock indices like the FTSE 100, the Dow Jones or the Nikkei 225. These numbers are often quoted in the news, reflecting how much they've moved up or down. But what exactly are stock indices and what do they represent?

A stock index measures the value of a specific section of the stock market.

Let’s break down stock indices into five simple steps.

Step 1: What are stock indices? 📈

A stock index measures how a group of shares is performing collectively.

These groups can be selected by:

• Country: Australia 200 (ASX 200), Wall Street (Dow Jones), US 500 (S&P 500)
• Sector: Technology, healthcare, financial
• Market size: Large, medium or small companies

For example, the Australia 200 (ASX 200) tracks the largest 200 companies in Australia. If the share prices of these companies rise, the Australia 200 also rises.

Step 2: Why do stock indices matter? 🌍

Indices offer a quick snapshot of how a market or economy is doing.

They're crucial indicators for:

• Economic health: A rising index suggests economic strength, while a falling one may signal weakening conditions.
• Investor sentiment: Indices reflect optimism or pessimism about market conditions.

For instance, if the Australia 200 (ASX 200) rises, investors might view Australia's economic outlook positively.

Step 3: How are stock indices calculated? 🧮

Stock indices are calculated in two primary ways:

• Capitalisation-weighted: Companies with larger market values have more influence. For instance, the Australia 200 (ASX 200), US 500 (S&P 500), and FTSE 100.

• Price-weighted: Stocks with higher prices have greater influence. Wall Street (Dow Jones) uses this method.

Example: If BHP has double the market value of Coles, a 1% change in BHP’s share price impacts the Australia 200 more significantly than the same change in Coles.

Step 4: What are the world’s major stock indices? 🌐

Every major market has at least one key index.

• ^{The US has several major indices representing different segments: Wall Street (Dow Jones), US 500 (S&P 500) and US Tech 100 (NASDAQ 100).}

Step 5: How can beginners trade stock indices? 📊

Indices aren't traded directly because they're numerical benchmarks, not physical assets. Instead, you trade financial products that replicate their performance:

• Exchange-traded funds (ETFs): Funds that mirror an index's performance
• Index funds: Managed funds that track indices
• Derivatives: Products such as contracts for difference (CFDs), futures, and options

Example: If you believe the Australia 200 will rise, you could buy an ETF or open a CFD position, profiting from the upward movement without owning the actual shares.