One of the most widely used terms in present day life is ‘stock market’. Booming economy and increased disposable income catapulted stocks as a key investment option and hence markets, its movement is assuming greater significance in our lives. market indices present the trend of stock prices and investors can track these indices to know the pulse of the market.
A market is a market for trading stocks of various companies, derivatives etc. Companies list their stocks on various exchanges and are traded among various investors. Fund traders, floor brokers, individual investors, pension funds, banks, insurance companies, mutual funds etc form part of this market.
Index literally means something that is an indicator or a sign. On the same lines, market index is a method used to indicate the performance of portfolios of stocks, mutual funds etc. Stock market indices can be many forms.
• Geography based – National index indicates performance of markets of a particular nation, where as global index tracks performance of stocks of companies irrespective of their country of domicile.
• Number based – Index reflecting the performance of a group of securities. Ex: Standard & Poor’s.
• Few indices track only the performances of major companies in a country like Dow Jones.
• Sector based – indices tracking the price movements of companies in a particular industry.
Indexes are very useful to analyze the trend of the stock market and note the investing patterns. Such movements usually help investors gauge the market mood and make investing decisions accordingly. However, one must take note that market indices are not market but only a reflection of the trading activities in the stock market. They provide a historical perspective for your future strategy.
Let’s look into the various ways of calculating stock market indices:
• Market capitalization based index calculations: Such method uses the market capitalization of the companies which are weighted by their effect on the index.
• Price weighted index calculations: Under this method all stocks are given equal importance and stocks are included at their quoted price.
• Fundamentally based index calculations: This method uses accounting aspects like book value, revenue, profits, cash flow etc of the companies. Such method usually does not track the market price of the stocks of companies.
• Attribute weighted index calculations: This latest method assigns weight to the stock in the index depending on the score it gets relative to the value attributes that define the criteria of a specific index.
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