What Is a Stock Index?
A stock index is simply a grouping of stocks used to measure the performance of a given sector of the stock market. Some examples of broad-market stock indexes are the Dow Jones 30 Industrials, the Standard & Poors 500, the NASDAQ Composite, and the Russell 2000. Each measures a different sector of the overall market (the Dow measures blue chip stocks, the S&P measures the same but on a larger scale, the NASDAQ Composite measures all the stocks on the NASDAQ, and the Russell 2000 measures a group of 2,000 small cap stocks) and, when viewed together, investors get a clear picture of the market's performance.
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Function
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The function of a stock index is to condense the information about dozens of different stocks into one easily understood format. If an investor is curious about how the Internet sector is performing on a given day, he can spend hours researching individual Internet stocks, or he can look up the Dow Jones Internet Composite Index in just a few moments. Likewise, if an investor is considering investing in an international market, he would be well served to track his target country's stock market index for some time before doing so.
Types
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The various types of stock indexes can be broken into several groups. They are Global indexes, Regional indexes, National indexes, and Equity Indexes. The first three groups measure the performance of stocks in a given geographic area. The last group measures the performance of stocks in a given sector of the market like technology or energy.
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Geography
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The bulk of the stock indexes measure stocks outside the United States. Some of the more common international indexes are the FTSE (UK stocks), the DAX (German stocks), the CAC (French stocks), the Nikkei (Japanese stocks), and the Bolsa Index (Mexican stocks). The oldest, and most commonly quoted, global stock index is the MSCI World index. Started in 1969 by Morgan Stanley Capital International (MSCI), this index measures the performance of stocks from 23 different developed nations.
Effects
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The effects of the largest and most commonly quoted stock indexes can sometimes be to the benefit or the detriment of unrelated stocks. For example, if the Dow and the S&P are up strongly, sometimes that is enough to raise the prices of stocks unrelated to the index just because the overall market sentiment is positive. Conversely, when the Dow and S&P are down sharply, the indexes often have a negative emotional effect on the overall market and may depress the prices of stocks unrelated to the indexes.
Expert Insight
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One of the best ways to take advantage of moves in the overall market without having to buy each of the components of a given index is to purchase an index fund. For example, if an investor is satisfied with the annual return of the S&P 500 but doesn't want to purchase 500 different stocks, he can just buy and S&P 500 index mutual fund, or buy an S&P Depository Receipt (AMEX:SPY) that trades like an individual stock.
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Resources
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