How stock indices work Author: Jim Knight
Ever had the feeling of the bears and the bulls fighting it out and you know nothing about it? Before understanding the details about a stock index, thorough knowledge about stocks is a basic priority. What are stocks? The stock of an entrepreneurial body is its total monetary worth simply put, it is the total money invested on the enterprise by the investors. It does not include non tangible assets. The stock of a company is divided into shares and a person who buys a share is known as a shareholder. A shareholder is a member of the company and is entitled to privileges such as right to vote on matters such as election of board of directors, right to share during distribution of company’s assets, etc. Now, every share that a shareholder buys is bought at a pecuniary cost. For companies that are hugely fortunate and pretty consistent in delivering profits, the share is much priced. And similarly, a company improper on profits will have a low valued share. Shares are bought or sold in the share market (also known as the stock market or the stock exchange). How does the index work? A stock index is a measure indicative of the cost of a share, irrespective of the company (as long as it is registered under a certain stock market). A stock index is nothing but the weighted mean of the price of the share of each company in the market, with the frequency of instance of a share being counted as the number of shareholders of that specific share. Although the above procedure mentioned is the simplest of ways a stock index can be calculated, contrary indices use contrary methods. Most indices in the world use the weighting function as the market capitalization (a measure of the bigness of the company). This implies the larger an enterprise is, the stronger its
result will be on the index. Thus if the big fish is sick, the index will inevitably go down, no issue how robust the smaller stocks are. A stock index does not forever provide us the right picture. The index measures the impact of a few stocks which are handpicked by a standard committee to represent the whole lot. However the stocks do not remain same year after year and are changed at random over time. Thus looking at a stock index for the last 10 years (say) does not necessarily display us the trading model of a set of stocks; rather it is a quite mixed bag of random trading patterns. The stock index can be of principally two types the global stock index, and a national stock index. A global stock index represents enterprises that are not domiciled under a specific nation and do business globally. And similarly, a national stock exchange represents enterprises domiciled under the power of a specific country. Common examples of worldwide and nationwide indices contain MSCI World, S&P Global 200 and S&P 500, Nikkei 225 etc respectively. The numbers at the end of the names indicate the number of companies registered under that index. For more information, please visit: www.alerian.com
Published on Sep 9, 2010
Ever had the feeling of the bears and the bulls fighting it out and you know nothing about it? Before understanding the details about a sto...