Have you ever watched the news and wondered what the heck they mean when they talk about the FTSE 100 or the Dow Jones? Well, that’s an index!
An index is basically a basket of stocks. It tracks and measures the average performance of all the shares inside it. In the UK, the biggest index is the FTSE 100 – a basket of the 100 biggest stocks in the country.
You can also find indices for specific industries. For example, you might have an automotive index, which is a basket of car stocks. Think of it like this: instead of buying one beer at a time, you buy ten all at once.
How does an index work?
Every day, shares are traded worldwide on stock exchanges. And each of these shares is ‘listed’ on a certain exchange. There’s one in London, one in Amsterdam, one in Paris, in Milan, Madrid, New York, throughout Asia, and so on.
Trading these individual shares is, of course, very exciting on its own. But what if you don’t want to trade individual shares? What if you want to invest in an entire group of stocks?
That’s how the index was born. As you can see, the principle is not too complicated. You make a collection of stocks and trade them all as one lump. Investing in an index is actually a great way to start trading if you’re a beginner.
Going back to the FTSE 100, the index will go up if the majority of big British companies are performing well. It goes down if most companies do poorly. It’s an average. Or, specifically, what’s called a ‘weighted average’.
Which companies are included in an index, and why?
Indices are often compiled on the basis of market capitalization, also known as stock market valuation. Let’s use our FTSE 100 example again. This index is like the Premier League – it features the most expensive companies on the market. These shares are known as ‘large caps’.
Then there are ‘mid-caps’, companies with a slightly lower market value. In the UK, these mid-cap stocks are included in the FTSE 250 – a collection of the 250 biggest British companies.
And then there are ‘small caps’; companies with a much smaller market value. They are often thrown into a basket together to form a small cap index.
By the way, the ‘market capitalization’ of a company is the total value of the shares in a company multiplied by its current share price. If a company has a million shares, each priced at £5, its market cap is £5 million.
Because share prices change every day, the market cap changes every day. So the composition of an index can change regularly. In the FTSE 100, for example, some companies might be included one day but relegated the next. Again, think of it like the Premier League, with teams promoted and relegated.
What’s the difference between the stock market and an index?
‘Stock market’ and ‘index’ are two terms that are often confused with each other. So again, just to be clear, the stock market (or exchange) is where shares, commodities, and currencies are traded. Like the London stock exchange.
An index is simply a collection of stocks (like the FTSE 100) which trades on that stock market. Of course, there can be multiple indices traded on one stock exchange.
Examples of indices
Now that you know exactly what an index is, let’s take a look at some of the biggest indices you’ll hear in the news (and you can trade all them on our BUX app!)
Dow Jones Industrial Average Index (often abbreviated as Dow Jones)
This index trades on the New York stock exchange. It comprises 30 major US stocks including Coca-Cola, Apple, Exxon Mobile, McDonald’s and Nike. It’s the oldest index in the US, and perhaps the most famous in the world.
This US index is compiled by credit rating agency Standard & Poor and contains – you guessed it – 500 companies. Since the S&P 500 tracks more companies than the Dow Jones, it is often used as a broader picture of corporate America.
The main German index, which initials stand for Deutscher Action Index, includes 30 shares of large German companies. Think Adidas, BMW, Volkswagen, and Lufthansa.
The main index on the Amsterdam exchange should also be included on this list (not least because BUX is based right here in Amsterdam!) It contains 25 companies including Heineken, Royal Dutch Shell and Philips.
You can trade all of these indices (and more) on the BUX X app. Simple!
All views, opinions or analysis expressed in articles are that of the author and do not represent the views of BUX. Neither BUX nor the author provide financial advice and these articles should not be construed as such.