Stock Indexes - what are they?

The London Stock Exchange has hundreds of listed companies and more every year seek approval to be members of the exchange. It becomes difficult to try to figure out which stocks are good for an investor. At the same time due to the difference in the nature of different types of business, the investor needs to figure out what stocks are good for him.

Different businesses have different ways to measure their performance. For example, if a business depends on bad weather to make a profit, during hot seasons, it is likely to perform poorly. On the other hand, in bad weather, the business will do well. You will need a method to compare this type of this business with another that is not affected by the weather.

This is where the stock market index comes in. A stock market index is a method of measuring a section of the stock market. By measuring the performance of a company based on the performance of other companies in the same type of business, an investor is able to make a reasonable decision on the best investment.

There are classes of stock indexes. The most common type of index is the broad based index that shows the performance a particular stock exchange. This type of index has been used to show the investor attitude about the state of the economy. In the UK, we have the FTSE 100. Other examples are the French CAC 40 and the German DAX.

You can also have stock indexes that reflect more than one stock exchange. A country can have more than one stock exchange and you can have a stock index that reflects the performance of different stock exchanges in a country. An example of this is the Dow Jones Wilshire 5000 Total Stock Market Index or the FTSE All Share Index

You can also have stock indexes that are more specialised and track on specific types of companies in an exchange. For example, you have the FTSE techMARK 100 that represents the performance of innovative and technology companies that are listed in the London Stock Exchange.

Since stock indexes are all about trying to get the value of a class of stocks, there are various ways to determine this price. Price weighted indexes and market value weighted indexes are the most common ways to figure out the value of stock indexes.

In price-weighted indexes, the price of a stock is what determines the value of the index. The price-weighted index only takes account of the price of the stocks in the index. Considerations like the size of the company, the capitalization or even the volumes traded of its stock are not important. As such, the price change of any single company can heavily influence the value of the index.

A market share weighted index otherwise called a capitalization-weighted index, takes the size of the company as well as its price into consideration. This means that even a small shift in the price of one big company will influence the value of the index.