Stock index

What a stock index means

A stock index is a number calculated from the prices of a defined group of shares. It acts as a scoreboard for a slice of the market. When people say that "the market rose today", they usually mean that a headline index such as the S&P 500, the DAX, the FTSE 100 or the Nikkei 225 moved higher.

An index is not a product you can buy. It is a calculation published by an index provider, a company that sets the rules for which shares are included, how much each one counts and when the list is reviewed. What you can trade or invest in are instruments that follow the index: exchange-traded funds, index funds, futures contracts, options, and contracts for difference (CFDs) quoted on the index level.

Indices are used by long-term investors to judge how a market has done, by fund managers as a benchmark to compare against, and by short-term traders who want exposure to a whole market in a single instrument instead of picking individual companies.

How it works

Every index has a rulebook, called a methodology. It answers four questions.

1. Which companies are eligible? Usually this depends on the country or exchange, a minimum size, and a minimum amount of shares available to the public.
2. How is each company weighted? The weight decides how strongly one share moves the index.
3. How is the level calculated? The weighted prices are combined and divided by a divisor, a scaling number that keeps the level continuous when companies are added, removed or split.
4. How often is the list reviewed? Most providers rebalance on a regular schedule, such as quarterly, and apply extra changes after mergers or delistings.

The main weighting styles are:

• Market-capitalization weighting. Each company counts in proportion to its market value, so large companies move the index more. The S&P 500 uses a version of this that counts only the shares available to the public (free-float).
• Price weighting. Each company counts in proportion to its share price, regardless of size. The Dow Jones Industrial Average works this way, so a high-priced share has more influence than its company size would suggest.
• Equal weighting. Every company counts the same, which gives smaller companies more influence than in a market-cap index.

Indices also differ in how they treat dividends. A price index only reflects share price changes. A total return index assumes dividends are reinvested. A net return index does the same after deducting an estimate of withholding tax. The same market can therefore show three different index levels.

A worked example

The numbers below are purely illustrative. Imagine a tiny market-cap-weighted index with three companies and a divisor of 100.

• Company A: market value 600 billion, weight 60%
• Company B: market value 300 billion, weight 30%
• Company C: market value 100 billion, weight 10%
• Total market value: 1,000 billion

Level = total free-float market value × 1,000 ÷ the base market value. On day one the base value equals today's value, so the level is set to 1,000 points. The divisor is the number that makes this scaling work and is adjusted whenever companies join, leave or split.

Now suppose that on the next day Company A rises 2%, Company B falls 1% and Company C rises 5%.

• A contribution: 60% × 2% = +1.20%
• B contribution: 30% × -1% = -0.30%
• C contribution: 10% × 5% = +0.50%
• Index change: +1.20% - 0.30% + 0.50% = +1.40%

The index moves from 1,000 to 1,014 points. Notice that the smallest company had the biggest percentage move but only a modest effect, because of its small weight. If you traded an index CFD at 1 contract per point, a 14-point move would be worth 14 units of the account currency, before costs.

Why it matters

An index summarizes the direction of a market and gives a clear benchmark. If your portfolio returned 6% while the relevant index returned 10%, you know you lagged the market, whatever the headline number looked like.

For traders, index products give diversified exposure with one position. They also tend to have tight spreads and deep liquidity compared with single shares. For cost-focused investors, index funds and ETFs usually carry lower fees than actively managed funds.

Concentration is the hidden issue. In a market-cap index, a handful of very large companies can account for a large share of the weight, so "diversified" can mean less than it sounds. Different indices of the same country can also behave differently because of weighting rules.

How to use it in practice

1. Identify exactly which index you are looking at, including whether it is a price, total return or net return version.
2. Read the methodology summary from the provider: eligibility, weighting, rebalancing dates.
3. Choose the instrument type that matches your goal: a fund for long-term holding, futures or CFDs for short-term exposure.
4. On a broker's pricing page, check the instrument's contract size, spread, trading hours and overnight financing, since index CFDs are often quoted under broker-specific names.
5. Check whether the CFD follows a cash index or a futures contract, because the two can differ slightly in price and in how rollovers are handled.
6. Compare the fund's tracking difference with its stated fee if you buy an ETF.

Common mistakes and misconceptions

• Believing you can buy the index itself. You can only buy an instrument that follows it, and that instrument has costs and small deviations.
• Assuming all indices from one country are equivalent. A large-cap index, a small-cap index and an equal-weight index can diverge for long periods.
• Ignoring dividends. Comparing a price index with a fund that reinvests dividends will make the fund look better than it really is.
• Treating a rising index as proof that most shares are rising. A few heavyweights can lift the level while most members fall.
• Forgetting that index CFD names differ between brokers, such as "US 500" or "Germany 40", and may follow futures prices rather than the cash index.

Risks and limitations

An index level can fall sharply and stay low for years. Diversification across companies does not protect against a decline of the whole market. Leveraged index products such as CFDs and futures can produce losses that grow faster than the index itself, and in some jurisdictions and on some account types losses can exceed the deposit. Index composition changes over time, so past index results include a survivorship effect: struggling companies leave and successful ones enter. Historic returns do not predict future returns.

How Brokeli looks at it

When we review a broker, we look at which indices are offered, how the instrument is named and defined, and what the published fee schedule says about spreads, commissions and overnight financing on those products. We use published research snapshots, so the contract specifications you read in our reviews and comparisons come from the same verified data. Availability of index products can vary by country and account type, so we show it per jurisdiction where known.