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It is extremely common for an investor to feel the need to know how the economy is currently doing. With a highly fluctuating market and up to millions of dollars in play, their curiosity is well justified.
How do they manage that curiosity? Where do they get all that information? The answer is stock market indexes.
An index is a collection of numerical data coming from a variety of companies across several industries. When investors observe and evaluate the gathered data, they can now compare current price levels with past prices. In other words, they’re now able to appreciate the market performance over a given amount of time.
Since there are a great quantity and variety of investors that focus on different market sectors, indexes usually come in great abundance and variety. Some indexes chose to focus on big companies, others on small companies instead. They even differ in size, with some tracking only tens of companies, while others can even manage thousands.
The most popular stock indexes available right now
- Dow Jones: An index that references the average stock price from the 30 largest companies in the U.S. stock market.
- S&P 500: An index that references the average market cap from the stock market’s largest 500 companies.
- Nasdaq: An index that references around 3,000 companies. All the companies in this index belong to the Nasdaq stock exchange and are highly focused on technology.
Some lesser-known indexes
As stated earlier, the world of stock indexes is a great one, both in sheer size and diversity. Understanding what types of indexes are within your reach at any given time and how they work is an excellent opportunity for you to compare them to your investment goals and needs. You can use this information to build your portfolio of stocks precisely as you want it to be.
Here are some examples of lesser-known indexes and how they work.
Some indexes only take into consideration stocks that agree with specific characteristics. Such is the S&P 500 Value Index, which only includes stocks that tend to trade for low costs but with a great chance to grow slowly. This is what is called value characteristics.
Another instance of an index that prioritizes given characteristics for their inclusions is the S&P 500 Growth Index. In this case, it only includes stocks belonging to companies with above-average sales growth and high-profit trades. In other words, companies with “growth characteristics.”
Some indexes track companies based on the summed-up value of said company’s total amount of shares, known as market caps. The S&P MidCap 400, for example, tracks companies with market caps between $1.6 billion and $6.8 billion, which as of today are being considered companies that belong right in the middle of the market.
There’s also the S&P SmalCap 600, which instead tracks companies with smaller market caps.
How to read a stock index?
Stock indexes are continually tracking how much their component stock values are rising and falling in real time. In short, to understand what an index has to say, you have to observe how much it is changing over time.
However, it is essential to consider the starting values of any stock index you are interested in using for reference.
When any stock index starts, it needs to select a “starting value” to reflect changes in values immediately from the get-go. However, not all companies chose a similar starting point. One company could start with a value of 250 and another one with 25,000. In this case, if you were to appreciate a rise of 250 points on the first one, it doesn’t necessarily mean that said index is performing far better than the second.
As shown in percentages, you should be looking for gains when comparing an older value to a newer one. Higher percentages always mean a more significant profit where you invest in stocks tracked by the index. For that reason, your priority should be towards tracking this instead of being towards tracking point movements.
The last point you should also keep in mind to properly read a stock index is to remember that stock indexes tend to track and prioritize stocks based on different criteria. Knowing the requirements on which it is based might help you better understand how each part contributes to the overall value and why other indexes might not be performing the same way.
Those criteria tend to be among one of the following three:
- Price-weighted indexes. Companies are tracked based on who has the highest stock prices in the market. The higher the prices, the higher the influence a company has on the index.
- Market-capitalization-weighted indexes. Companies are tracked based on who has the highest market caps. The higher the market cap, the higher the influence a company has on the index.
- Equal-weight indexes. Regardless of how different a given company has when it comes to stock prices and market caps, these indexes prioritize both factors equally. They have as much weight as one another.
Specific uses for stock market indexes
- By tracking the biggest and most popular stock market indexes available, you can observe a general overview of the overall stock market’s performance.
- By tracking smaller and lesser-known indexes, you can instead appreciate a specific market performance review.
- You might also be able to invest in index funds, which automatically make investments in your names while constantly modifying themselves to match a pre-chosen index’s performance. This is a low-cost and highly effective way to create wealth over time.