How stock indices work

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U.S. stock index futures pointed to a flat open on Monday as investors looked ahead to the latest economic data and corporate earnings to give direction to a market near record levels.
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Editor's note: Originally published on June 23, 2014 We've experienced a number of years over the recent past where the broad stock market average produced a negative rate of return. The years 2000, 2001, 2002 and 2008 all produced negative...
The Economic Times  Jul 22  Comment 
MSCI will consult with investors about adding Saudi Arabia to its broader stock indices and could make a decision to include it as an emerging market in June 2015.
TheStreet.com  Jul 11  Comment 
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Reuters  Jul 11  Comment 
U.S. stock index futures were modestly higher on Friday, indicating a rebound from recent losses, though major indexes remained on track for their biggest weekly decline since April.
SeekingAlpha  Jul 10  Comment 
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By Dividend Growth Investor: US stocks these days are offering much lower yields than the rest of the world. For example, the S&P 500 yields less than 2% while UK stock indices are yielding more than that. Given the fact that foreign companies are...
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China’s Stocks Drop Most in Two Weeks on Losses for New Economy China’s benchmark stock index fell the most in two weeks, led by technology and health-care companies,...




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A stock index is generally a portfolio of stocks, bonds or other kinds of investments which are used to represent either segments of an exchange or the whole exchange. One of the most common ways to understand a stock index is to have a look at the composition of the stocks it represents. Generally, the set of rules require the stocks to satisfy certain criteria, such that[1]:

  • All the investments in the index are subject to selection.
  • Includes calculations and rules for weighting of the index components.
  • Provides specific instructions for adjustments to maintain consistency.

How Stock Market Indexes are classified

The benchmark indices of various exchanges not only represent the stocks, but the scenario of the market as a whole. Hence, they are used to depict the overall health of the economy as well. Understanding how the index works, is a good way to begin analysis on various stocks and their importance to the economy. A good way to analyze an index is to understand the composition of the stocks it represents.

A broad based index or composite index is the one which covers almost all stocks on the exchange (or a certain majority percentage of the market capitalization on the exchange). The main purpose of the broad based index is to act as a proxy for the performance of the economic conditions of the entire market, or reveal investor sentiment towards the market.

Based on the definition of a stock index, a global index could include indices which span across exchanges and possibly countries. The Dow Jones Wilshire 5000 Total Stock Market Index spans all publicly traded index in America, excluding foreign stocks and ADRs. The Euronext 100 includes stocks from all over the European Union and the Russell Investment group have something called the Global Index.


References

<Broby, D., "Equity Index Construction", The Journal of Index Investing, Fall 2011, Vol. 2, No. 2: pp. 36-39 />

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