What do you need to know about stock indices
A huge number of shares and bonds are traded on the securities market.
and derivative instruments. It is not uncommon to see them move in different directions. Some stocks are growing, some are falling at the same time. Stock indices are necessary for an investor to understand the state of the securities market in general. About them in today’s article.
The variety of financial instruments is huge, that is why whole index families are widely spread, among which an investor can choose a market sector he or she prefers to work in.
Stable growth of indices shows that the economy is in good shape, income and employment are growing. If the indices fall, it means the opposite – the final demand and profits of companies fall. The indices are classified by region, by capitalization: large, medium and small companies and by industry – the whole industry: transport, retail trade, etc.
HOW TO CALCULATE THE STOCK INDEX
Exchange indices are determined in two main ways: as an average of all prices of all shares included in the index and as a weighted average of all prices of all shares included in the index.
The easiest way to get the average share price is to find the arithmetic average for a certain sample of shares. This is how the Dow Jones index works: the arithmetic average is calculated for the share prices of 30 largest corporations, this average has a monetary dimension.
THE DOW JONES INDEX WAS CREATED BY JOURNALISTS CHARLES DOW AND EDWARD JOHNSON IN 1928.
Usually the index is calculated not for all shares traded in the market, but for a relatively small sample. The number of shares in the sample is usually given at the end of the index name – S&P 500, FT-SE 100, Nikkei 225, DAX 30 etc.
To ensure that changes in the index correctly reflect changes in the market, the distribution of issuers by capitalization and industry affiliation within the sample should correspond to the distribution in the market as a whole. The requirement of representativeness is often violated – usually the largest companies are selected for index calculation, while changes in the sector of medium and small companies are not taken into account.
Industry ratios change, and the sample would need to be revised too often to account for these changes correctly. The use of computers made it possible to calculate indices for all traded stocks without making samples. For example, the New York Stock Exchange Index (NYSE) is calculated for all listed ordinary shares, and there are approximately 3000 of them.
Indices constructed for the same market are always highly correlated: regardless of samples or averaging methods, market growth will cause growth of almost any index. However, the speed of change of different indexes may vary significantly, divergence may occur on short periods.
Differences or divergence of indices can be used for forecasting. For example, if a new high of the blue chip index is not confirmed by a new high of a wider index, the market is likely to fall. The globalization of investment processes has led to the correlation of indices in different countries, so that one can make a forecast on the behavior of US indices, for example, Germany or Russia, etc.
FUTURES ON S&P 500 AND NASDAQ 100 INDICES ARE TRADED AROUND THE CLOCK,
WHICH ALLOWS US TO KEEP PACE WITH DEVELOPMENTS IN THE U.S. MARKET
IN THE USA
Dow Jones Industrial Average – calculated on the basis of share prices of 30 largest industrial enterprises of the USA.
Nasdaq – calculated on the U.S. stock exchange of the same name. It has two main types: Nasdaq Composite and Nasdaq 100.
Nasdaq Composite includes shares of more than 3000 companies traded on this exchange. These may be not only American companies.
Nasdaq 100 includes shares of 100 non-financial sector companies traded on this exchange.
S&P indexes – calculated by the international rating agency Standard & Poor’s Financial Services LLC. The best known index S & P 500, which consists of shares of 400 industrial, 40 utility, 40 financial and 20 transport companies with a total capitalization of more than 80% of the capitalization of all companies represented on the New York Stock Exchange. In addition, there is the S&P 100 index – consists of 100 companies whose option contracts are listed on the Chicago Stock Exchange.
Nyse Composite – is calculated on the New York Stock Exchange on the basis of shares of more than 2000 companies (as American,
and other large international companies listed on the exchange) with a total capitalization of over $20 trillion.
DAX 30 is the largest stock index in Germany and includes shares of the 30 largest companies listed on the Frankfurt Exchange.
CAC 40 is a French stock index calculated on the basis of the prices of forty largest companies listed on the Paris Stock Exchange.
FTSE 100 is a British index created by the analytical agency Financial times on the basis of shares of 100 companies of blue chips of the national stock market.
Euro Stoxx 50 – created on the basis of shares of 50 largest companies located in the European Union.
Nikkei 225 is the oldest Japanese stock index consisting of shares of 225 companies listed on the Tokyo Stock Exchange.
TOPIX is another Japanese stock exchange index, which consists of shares of companies included in the first section of the Tokyo Stock Exchange.
Hang Seng is the largest Chinese stock index based on the quotations of 34 companies traded on the Hong Kong Stock Exchange. The total capitalization of these companies is about 65% of the total capitalization of companies on the stock exchange.
RTS – includes shares of the largest Russian companies traded on the Moscow Stock Exchange. The index is calculated based on share prices expressed in dollars.
Moscow Exchange – consists of 50 shares of companies representing major sectors of the Russian economy. The list of companies included in the index is reviewed every three months.
MSCI Russia – the index is calculated by the international company MSCI inc. along with the indices of other developing countries. Russian companies are selected for the index on the basis of their capitalization and the number of free float shares. The index is calculated in dollars, and the list of companies included in the index is reviewed quarterly.