What is a Composite Index?

A composite index in the stock market is a statistical representation of how a group of equities or stocks perform as a whole. The grouping can be a number of stocks of a like kind, such as mostly technology securities, or it can be a broader measure of overall stock market performance in some of the largest stocks that are traded in a particular region. Often, whether the financial markets are advancing or declining during a particular trading session is associated directly with the direction of a composite index.

Index performance can be useful to investors in gauging the health of their particular investment portfolio. For instance, if an investor holds many technology shares in a portfolio and wants to measure how market gains or losses compare to the overall industry, he or she might compare individual-portfolio performance with that of a composite index, such as the Nasdaq Composite, which is comprised of 5,000 individual securities in the United States, including many tech stocks. A composite index might not be only industry specific, it might represent an entire regional stock market more broadly. For instance, the New York Stock Exchange Composite Index in the U.S. is a measure of price changes in all of the common stock securities that are traded on the New York Stock Exchange.

Investors who are not interested in taking on excessive stock market risk can invest similarly to the way a stock market index is constructed for diversification. Some investment firms that sell mutual funds, which are a basket of stocks in which multiple investors can invest, will create portfolios that resemble a particular stock market index on purpose. This is because they are giving investors an opportunity through one lump-sum investment to gain exposure to some of the most widely traded securities, or stocks that are bought and sold in heavy volume on a daily basis. For instance, investors might select a portfolio that is comprised of similar stocks to the Nikkei 225 index, which is representative of trading activity on the Tokyo Stock Exchange in Japan. The mutual fund portfolio basically advances and declines alongside the performance of the broader Japanese market index.

Performance of regional index composites might be calculated differently. The Nikkei 225 is calculated based on the price of 225 Japanese stocks. These securities are reviewed annually and must maintain a certain price threshold to remain in the index. In the U.S., companies must maintain a certain price level to continue trading as part of a major stock market index, and if they fail to do so, they can be eliminated at any time.