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What is a Stock Market Index?

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  • Written By: Eric Tallberg
  • Edited By: Bronwyn Harris
  • Last Modified Date: 01 December 2016
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Stock trading and financial investment in the stock market is serious business. Anyone with significant financial assets tied to the world’s stock markets will often pay particular attention to a specific stock market index. This is the delineation of the relative value of stocks that make up a particular market sector such as heavy industry, technology, telecommunications, healthcare, etc.

An index of any sort is, essentially, an aggregate. A stock market index is, therefore, composed of the combined performance of a certain aggregate of individual publicly-traded company stocks best representing that specific sector of the market. The sector could be composed of hundreds of different publicly traded companies, or as few as thirty or so

Standard and Poor’s 500 Index (S&P 500), which tracks large- and mid-cap U.S. stocks, is one of the better-known examples of a stock market index. Perhaps the most widely quoted stock index is the Dow Jones Index, which measures the performance of solely large-cap stocks and is the premier focus of the New York Stock Exchange (NYSE).

A stock market index should not be confused with a stock market average. A stock market average is reflective of the entire market, while the index reflects the deviation from statistical norms for a specific segment of the market. A stock market index may be valued based on a number of various factors, while an average is solely an arbitrary reflection of that value within the market as a whole.

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Weighting of a stock market index is the classification of the value of the index through a formula used to specify its price. Various methods are utilized to weigh a market index. It may be price-weighted, such as the Dow Jones Index, where the price of each aggregate of stock is the sole value determinant of the index price. In this case, the price gain or loss of even one stock can affect the value of the entire index. Conversely, for a market-share weighted index, the price of the index is balanced relative to the number of stocks in the index, as opposed to the collective value of the stocks.

Diversification through market index funding provides a relatively low-risk method of stock investment. Index funding involves investing small amounts of capital in a broad cross section of individual stocks within an index. These stocks are lumped together in a portfolio and the precipitous gain or loss of one particular stock will not discernibly affect the overall performance of the index. Mutual funds are the most common form of index funding.

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