From DAX to Nasdaq: A Guide to Popular Stock Indices
18 April 2023
You must have heard the news about the stock market rising or falling. Usually, you can see some stock index to describe the rise or fall compared to yesterday’s market. If you are new to financial markets, you must be fascinated by how the stock index reflects market trends.
The stock index is the score of a set of stocks. Usually, every stock exchange has its score. It plays a vital role in helping market participants measure the performance of a market segment. Does that make you more curious about the stock index?
This brief guide will help you understand various aspects of stock index and why it is critical for investors. Stay tuned to learn stock index meaning, relevant terminology, types of stock indices, significant stocks weighting methods, ways to invest in stock indices, purpose of the stock indices, and the most popular stock indices.
What are Stock Indices or Indexes?
A stock index is a measure of a basket of stocks. Stock Indices are calculated using an average of given stocks, either grouped via market segments or some other measure, namely the top 100 stocks on FTSE by market cap. The average can be weighted or unweighted. Another example of stock indexes is Nasdaq, which enlists prominent technology companies.
A stock index evaluates the performance of a group of stocks or market segments. In some instances, it may be a measure of the market as a whole. The analysts use the stock index as a measure of performance.
Before we deep-dive into calculating the stock index and its various types, let’s understand some relevant terminology:
Market capitalization is the total company value calculated by multiplying the share price by the number of outstanding shares. In a nutshell, it's the total market value of a company. Example, AAPL (Apple Inc) market cap was approximately $2.62 Trillion at the time of writing the article.
Free float is a definition by which number of outstanding shares are defined. It is usually the total number of shares available to buy and sell. This does not include privately held shares or government-owned shares, for example. Market cap calculated using the free float method to describe the outstanding shares is the most common when calculating indices. No need to get confused, we will explain this in greater detail later.
What are the Different Types of Stock Indices?
Stock indices can be classified based on the weighting method. Notably, the weightage assigned to stocks defines the impact the change in a stock price may have on the stock index value.
Though there are several types of stock indices based on the weighting method, let’s look into the most common ones:
Market-Cap-Weighted Stock Index
We have discussed market capitalization before. It is the total market value of a company based on its current stock price multiplied by the total outstanding shares in the market.
Based on this criterion, component stocks in a stock index are weighted. In this type of stock index, every component stock in the index is weighted based on its total size. This means large companies with a larger market cap will be represented more heavily or with greater weight in the index.
For instance, Apple has a market cap of US$ 2.62 trillion and has about 12% market cap weighting in Nasdaq composite index. Similarly, Amazon has a market capitalization of US$ 1.05 trillion and a 6% weighting in the Nasdaq composite index.
This is the most common method of calculating Stock indices.
Equal-Weighted Stock Index
Equal-weighted stock indices remove the market-cap barrier and provide similar value to all the underlying stocks in the index. Thus, companies of any size get equal importance in the index.
Let us understand in a simpler way. The equal-weighing method is similar to investing $1 in each component stock of the index. Notably, Nasdaq and FTSE provide equally-weighted index versions. If we were to calculate an Equally weighted (Unweighted) version of Nasdaq we will allocate £1 each to Apple and Amazon unlike Market Cap based indices where we would allocate $12 and $6 (based on a total $100 allocation).
Price-Weighted Stock Index
As the name suggests, this index type weighs the component stocks by their prices. Every company makes a fraction of the index proportional to its stock price. The stock prices of all the component stocks are added, and the total is divided by the number of companies in the index.
So, a stock with a higher price will have a higher weight in the index, while a lower share price will have less weight in the index. This means stocks with higher share prices will have a significant say in the overall index performance and the market it represents.
Price-weighted indexes face criticism that a stock with a higher per-share price does not necessarily mean it has impressive and significant market clout. The price-weighted index is a bit arbitrary. For example Dow30 is a price weighted index with Intel only representing 0.57% share in the index and Goldman Sachs representing 7.38% despite being similar size companies according to market cap.
After an overview of the stock indices types, let’s consider some examples. Commonly followed stock indices, like NYSE and Nasdaq, are free-float adjusted market-cap-weighted stock indices.
NYSE Composite Index is calculated based on price and total return, including dividends. Popular stock indices like S&P 500 and Nasdaq 100 in the US have equal-weighted index versions.
Ways to Invest in Stock Indices
Market Cap-Weighted and Equal-Weighted Stock Indices have benefits and limitations. So, traders and investors should deeply analyze the market to draw a trading strategy. Though you cannot directly buy stock indices, you can invest in them through various financial instruments, like:
Investing in stocks that well represent an index
Index Mutual Funds
Exchange-Traded Funds (ETFs)
Index Contract for Difference (CFD)
What is the Purpose of Stock Indices?
The stock market indices are the most popular numbers in finance and investing scenarios. Stock indices reflect economic health and growth. The movements in the stock index graph can imply many crucial aspects of the overall economy and many other parameters.
Stock indices are deeply integrated with the investment management landscape. Stock market indices serve as benchmarks for investors to manage their investment portfolios and help them follow the financial markets.
What are the Most Popular Stock Indices?
Let’s take a glance at the most popular stock indices followed globally. Notably, these stock indexes guide a significant part of world stock trading and help market participants analyze market trends to make informed decisions.
Nasdaq 100 is the stock index comprising the 100 largest non-financial companies listed on the Nasdaq stock exchange. It is a modified market-cap stock index. It is better known for its technology-related companies listed in a large number.
Example stocks: Cisco Systems Inc., Cognizant Technology Solutions Corporation, eBay Inc., Atlassian Corporation.
Standard and Poor’s 500 is the stock market index tracking the performance of the 500 largest companies listed on the stock markets in the United States. It is among the most popularly followed equity indices.
Example Stocks: Tesla Inc., Apple Inc., NIKE Inc., Amazon.com, Inc., Walmart Inc.
DOW 30 is short for The Dow Jones Industrial Average. It is a globally followed stock market index. It gauges the performance of the 30 most prominent companies listed on the US stock markets. It is a price-weighted index tracking the performance of 30 well-known companies. It is among the most-watched stock market indexes globally.
Example Stocks: Intel Corp, Johnson & Johnson, JPMorgan Chase & Co, Coca Cola Co.
Deutscher Aktien Index is a popular stock index with 40 German blue chip companies trading on the Frankfurt Stock Exchange in Germany. The companies under the DAX index are the largest and the most liquid German brands, known for their reliability and profitability in good and bad times.
Example Stocks: Adidas, Airbus, Allianz, BASF.
The Financial Times Stock Exchange Index, informally known as the ‘Footsie,’ is the stock market index comprising the 100 companies listed on the London Stock Exchange with the highest market capitalization. The FTSE index measures their performance.
Example Stocks: Admiral Group PLC, BP PLC, Coca Cola Hbc AG, Endeavour Mining PLC.
By following these stock market indexes, investors can keep track of the most significant stock exchanges on a global scale. Stock indices can be a guiding reference to manage funds to diversify your portfolio and make the most of your investments.
As the guide takes you through various aspects of the stock index, including meaning, calculation, and importance, we hope it makes you familiar with the concept. As the stock indices move according to their underlying stocks, they help you analyze the market trends. They have been a crucial statistical tool for investment management across the world.
CFD Indices can be a feasible option to start. Yet, you must analyze the market properly, relying on reputed market data vendors like us for CFDs. We cover 11 index markets for CFDs. Trust us for reliable, accurate, and unbiased CFD data to make informed trading decisions in the long run.
We suggest you read some must-read stock indices books by prominent financial authors. You can also refer to online resources that would elaborate on the concepts and let you know how to read, understand, and implement stock market indices for your analysis.