Introducing the financial markets

Lesson 5 of 10

What are stock indices?

You may have already heard of stock indices such as the FTSE 100, the Dow Jones or the Nikkei 225. Numbers often quoted on the news, or in the business section of the newspaper, usually alongside a value saying how much they've moved up or down.

But what are they? And what do they represent?

A stock index is a measurement of value of a certain section of the stock market.

This 'certain section of the stock market' can be:

An exchange (like the Tokyo Stock Exchange or NASDAQ)
A region (such as Europe or Asia)
Or a sector (energy, electronics, property, etc)

The S&P 500 for example, is a number representing the 500 largest US-based companies traded on the New York Stock Exchange.

If, on average, the equity price of these companies goes up, then the S&P 500 will rise with them. And if the equity prices fall, it will drop.

Why are they important?

Stock indices give traders and investors an indication of how an exchange, region or sector is performing.

The ASX 200 for example, tracks the performance of 200 of the largest companies in Australia. If the ASX 200 starts to rise, then on average these companies are performing well. A rising ASX 200 tells investors that, generally, the state of the Australian stock market is improving.

And if the Australian stock market is on the up, then more often than not, the entire Aussie economy tends to be doing well. So, movements in the price of major stock indices can often give traders an indication as to the health of an entire country.

That's important information when planning your next trade.

What are the major stock indices?

Most nations have one major stock index that represents the largest companies in that country. For example:

FTSE 100 UK
DAX Germany
CAC 40 France
IBEX 35 Spain
FTSE MIB Italy
Nikkei 225 Japan
Hang Seng Hong Kong
ASX 200 Australia
TSX 60 Canada

 

However, in the US there are several major indices, all based on slightly different sections of the market. The three main US indices are:

Dow Jones Industrial Average (DJIA)

One of the oldest and most quoted indices, the Dow Jones Industrial Average represents 30 of the most influential companies in the US. It was first calculated in 1896 and historically was made up of firms involved in heavy industry. Nowadays this association has been all but lost.

S&P 500

More diverse than DJIA, the S&P 500 is based on the value of 500 of the largest US shares listed on either the New York Stock Exchange (NYSE) or NASDAQ. It was first used in its current form in the 1950s and today represents around 70% of the total value the US stock market.

NASDAQ-100

Established in 1985, the NASDAQ 100 is based on 100 of the largest non-financial companies listed on the NASDAQ exchange in New York City. It represents firms across a number of sectors, but in particular computing, telecommunications and biotechnology.

Lesson summary

  • A stock index is a measurement of value of a certain section of the stock market
  • Major stock indices can give an indication as to the health of the equity market (and sometimes the economy) of a particular country or region
  • Most nations have one major index. The US has three: the Dow Jones Industrial Average, S&P 500 and NASDAQ-100
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