What are Indices?
Indices measure the price performance of a collection of stocks on an exchange.
What are the benefits of stock indices and how to trade them?
Since indices track the average value of top stocks on an exchange, the index indicates how well economic sectors or industries are performing. Stock performance can be assessed against these benchmarks. Remember, the index isn’t a tradable asset – it is possible to trade derivative financial instruments which track the value of the index. These include futures, options, and funds. To better grasp these concepts, it’s important to illustrate the main features of an index.
Which stocks are included in an index and how is the average gauged?
There are two ways of deriving indices, notably the selection of stocks and the determination of the average. The specific stocks that make up an index can be selected based on several factors, including the value of the stock, or the company’s market capitalization (market cap). A committee of experts can also determine which stocks will make up an index based on their preferences. Once stocks have been chosen, it’s a relatively simple process to determine the index value. This is done by either a simple or weighted average. Let’s take a look at several indices.
CFD Indices Available for Trading
The DAX 30 Index
The DAX 30 is a cap-weighted index measuring the value of the 30 top-performing companies on the FSE (Frankfurt Stock Exchange). It is owned by a publicly-traded company known as Deutsche Bӧrse AG. The DAX 30 index tracks the performance of the 30 biggest and most liquid companies on the German stock exchange. These account for approximately 80% of the total market cap of publicly listed companies. The DAX was first published on July 1, 1988, with a starting index level of 1163 points.
The Dow Jones Industrial Average (DJIA)
Of all the indices in the world, none is quite as famous as the Dow Jones Industrial Average (DJIA). It ranks second only to the Dow Jones Transportation Average. Created by three financially savvy journalists in Charles Bergstresser, Edward Jones, and Charles Dow, it was the latter two that decided which companies to include in this index. The first average was published in 1885. Nowadays, a group of experts determines which companies to include in the Dow Jones Industrial Average.
Currently, a fixed divisor measuring 0.45798 is used with the 30 blue-chip stocks included in the average. This is then adjusted to account for spin-offs and stock splits. At inception in 1896, 12 industrial stocks were included in the DJIA. Stocks are selected from listed companies on the NYSE which is owned by the Intercontinental Exchange/Euronext as well as the NASDAQ which is owned by the Wallenberg family of Sweden. Stocks included in the Dow Jones cover a broad spectrum of companies, not just heavy industry. Presently, the Dow Jones is managed by S&P Dow Jones indices which is a joint venture between S&P Global, News Corp, and the CME Group. It is currently owned by the McGraw-Hill Publishing company.
The S&P 500 Index
This stock market index tracks the performance of approximately 500 publicly listed companies in the United States stock market. These companies cover 11 sectors of the economy and present an overall perspective of the economy and the US stock market. This free-float, cap-weighted index measures every share’s value by market capitalization + the number of outstanding shares held by the public. These specifically exclude government shares and company insider shares.
A committee of experts selects 500 company shares, with consideration given to sector, industry, exchange prominence, trading tenure, liquidity, market capitalization, and viability. S&P – a credit rating agency – publishes the index. It is now owned by S&P Dow Jones Indices. Each company in the S&P 500 index is assigned a specific weighting. This is calculated by dividing the individual market cap of the company by the total market cap of the S&P 500 index. Companies with large market valuations are weighted more heavily than companies with small market valuations.
The Nikkei 225 Index
The Nikkei 225 in Japan is a price-weighted index. It assesses stocks based on their performance in the TSE (Tokyo Stock Exchange). The world’s largest finance newspaper, Nihon Keizai Shimbun has calculated the Nikkei 225 index since 1950. This is the premier index of Japanese stocks, and it has been trading for 70+ years. Some 225 stocks are included in the Nikkei 225, notably domestic common stocks traded on the TSE.
An annual review is responsible for the changing constituents, and selections are made according to sector balance and liquidity. The calculation method used ensures that each component stock price is adjusted by a price adjustment factor. This negates the effect of outside elements that are unrelated to market movements in this price-weighted index.