Stock Market Indices - Types and What They Indicate

Introduction to Stock Market Indices

Stock market indices evolved from the day-to-day summaries of price fluctuations of stocks published by newspapers in the late 19th century, with what would become one of the most important indexes, Dow Jones, starting in 1844 in the newsletter Customer's Afternoon Letters by Dow Jones and Co. Stock market indices began to gain in popularity in the inter-war period in the US, with the rest of the world following suit post Second World War. Stock market indices can also be traced to the development of macroeconomics. Macroeconomics involves, among other things, the study of business cycles and their importance was recognised early in the 20th century, with the publication of the 'Harvard barometer' in the early 1920s.

What Are Stock Market Indices?

Stock market or share market indices measure the share market or segments of it and the price fluctuations within them, providing investors accurate data with which to calculate market performance. Stock market indices work as a barometer for the economy. Investments in stock market indices are indirect, through index funds or exchange-traded funds.

Types of Stock Market Indices Based on Weighing Methods

Stock market indices can be categorised by the index methodology or rules while placing stocks in their charts. These include:

• Indices that weigh constituent stocks by their market capitalisation are known as market capitalisation-weighted indices.

• Indices that weigh the companies' stocks using the free-float methodology wherein only ordinary shares available for trading are counted are known as free-float market capitalisation weighted indices.

• Indices that weigh a company's stocks by the price of one share divided by the price of a company's total shares are known as price-weighted indices.

• Indices that weigh constituent stocks by fundamental factors rather than financial data are known as fundamentally based indices.

• Indices that are underweight on large-cap stocks and overweight on small-cap stocks are equal-weighted indices.

• Indices that weigh constituent stocks by the inverse of their price volatility are known as volatility weighted indices.

Types of Stock Market Indices Based on Coverage

Stock market or share market indices can also be categorised by the area they cover. These include:

• Indices that represent the performance of national stock markets are known as Nation or country coverage indices. The major Indian indices such as the Nifty 50 and BSE Sensex fall under this category.

• Indices that represent the performance of the global stock market are known as global coverage indices.

• Indices that represent the performance of stock markets in any particular geographical region are called region coverage indices.

• Indices that represent the performance of specific segments of stock markets are known as segment coverage indices.

• Indices that represent the performance of specific exchanges are known as exchange coverage indices.

• Indices that act as benchmarks for the market performance of investments, such as BSE Sensex, are called benchmark indices.

• Indices that only represent the performance of companies that matches specific ethical or social criteria are known as ethical indices.

What is Nifty and Sensex & How to Invest in Them

Conclusion

Stock market indices are essential indicators used for calculating long term evolution and financial trends. Thus, investors generally study and use several indices to have more accurate data for their calculations and plan their investments accordingly.

Disclaimer

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