Stock indexes can be confusing at times. There are different types, but before we delve into that, it’s important to have a rudimentary understanding of what exactly stocks indexes are. Every day, millions of investors all over the world are buying and selling hundreds of thousands of stocks.
With so many stocks flying around, things get confusing mighty quickly. That’s why many different tracking companies – or “stock indexes” have popped up over the years. Their job is to track how certain segments of the stock market (or entire stock markets themselves) are doing in their day-to-day trading activities.
Different stock indexes keep tabs on different kinds of companies. Some stock indexes focus their tracking activities on solely large-cap companies, while others keep their sights on just the small-cap variety. Still others track the stock market as a whole. For instance, one very broad stock index in the United States is the Standard & Poor 500 (S&P 500). This index tracks the broadest range of businesses – in fact, it covers 500 of the largest companies in the US today.
Big Stock Indexes
Big stock indexes are the most common variety of stock trackers out there today. Arguably the most well-known of these types of stock indexes is the Dow Jones Industrial Average. This index tracks the ups and downs of thirty of the most highly influential businesses in the United States today. Some examples of these big players tracked by the Dow Jones include General Motors, General Electric, and Wal-Mart. The Dow Jones places precedence on the most expensive stocks out there, however, so a big stock index like this one is actually considered a “price-weighted index.”
This generally means that the index rises and falls depending on the fluctuations of these thirty companies as a whole. Some analysts think that this does not provide an accurate representation of the world’s economy; they don’t think that it paints a real picture of the rises and falls of every company out there.
Market Value-Weighted Stock Indexes
The previously-mentioned S&P 500 is different from a price-weighted index. It’s called a “market value-weighted index,” which means that the S&P 500 measures and tracks the combined value of stocks that all the companies in the index sell to investors. Basically, this means that stocks sold big the largest companies and with the largest market shares will have greater weight within the stock index.
It makes sense for larger companies to have more weight within a market-value weighted index, but this type of index does have its downfalls. For example, sometimes when a bubble develops that artificially inflates one segment of the economy, such as the bubble created by tech stocks in the 1990s, it can cause a ripple effect when it bursts that negatively impacts the rest of the stocks in the index and devalues the stock index as a whole.