What Are The Different Types Of Stock Indexes?
There are several key categories:
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Benchmark indices. These track the overall market's performance
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Sectoral indices. These focus on specific industries or sectors, like technology or healthcare
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Market-Cap based indices. These classify stocks based on their market capitalization – large, mid, or small-cap
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Types of stock indices by coverage. These differ in the extent of their market reach, spanning from global to regional and country-specific indices
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Types of indices by weighting method. This category varies in how it assigns weight to its components
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Ethical stock market indices. These consider environmental, social, and governance (ESG) factors in addition to financial performance
Depending on the purpose of the indices and the method of calculation, there are: Benchmark, Sectoral, Market-Cap based, and more.
There are more than 65,000 stocks traded on exchanges worldwide. To help measure this wide variety, stock indices have been created. This article is about what types of indices are available and how they can be useful for novice investors to understand stock markets.
Stock indexes categorize groups of stocks based on specific criteria. Understanding the types of stock indices can guide your investment decisions.
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Benchmark indices serve as yardsticks to gauge the performance of a wider market or a specific segment within it. They represent a group of stocks selected to reflect the overall market's movements. Investors and fund managers use this as benchmarks to assess the performance of their own portfolios and investment strategies.
Examples: the S&P 500 which includes top 500 US companies, is the most tracked benchmark. If an investment portfolio generates a return of 8%, but the S&P 500 indicates a 10% increase during the same period, it shows that the portfolio has underperformed compared to the market. Also you can be interested in the best time to trade SPX.
Sectoral indices
Sectoral indices concentrate on specific industries or sectors within the market. They are stocks from a certain sector, such as technology, healthcare, or finance. These indices deliver insight into the performance of a specific segment of the economy, allowing investors to evaluate the health and trends of that particular industry.
For example: the Technology Select Sector SPDR Fund (XLK) is an exchange-traded fund (ETF) that tracks the performance of prominent technology companies like Apple, Microsoft, and Amazon. This ETF is an example of the technology sector's performance.
Sectoral indices are for investors who are looking to diversify their portfolios or those interested in investing in a specific industry.
Large cap, mid cap, small cap stocks
Large-cap, mid-cap, and small-cap stocks categorize companies based on their market capitalization.
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Large cap stocks. Financially stable companies with a market capitalization typically exceeding $10 billion often operating globally. Examples are Apple, Google, and Amazon
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Mid-Cap stocks. Companies with a market capitalization between $2 billion and $10 billion typically in a phase of growth and expansion. Examples include Etsy and Zillow
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Small Cap stocks. These are smaller companies with a market capitalization between $300 million and $2 billion. They are usually newer or less established compared to large and mid-cap companies. Examples include Stitch Fix and Vital Energy Inc
Investors use these categories to diversify their portfolios based on risk tolerance. Large caps offer stability, mid caps offer a balance of growth potential and stability, while small caps provide higher growth potential with increased risk.
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Types of stock indices by coverage
Global coverage indices encompass stocks from various countries worldwide. They provide a comprehensive view of the global market. For instance, the MSCI All-Country World Index (ACWI) tracks stocks from both developed and emerging markets.
Regional coverage indices focus on specific geographical areas, such as Asia-Pacific or Europe. These indices offer insights into the economic performance of a particular region. An example is the FTSE Developed Europe Index, which includes large and mid-cap stocks from developed European countries.
Country coverage indices concentrate solely on the stocks of a single country. The DAX, for instance, tracks the performance of the top 40 companies in Germany.
Types of indices by weighting method
Indices by Weighting Method refer to how the components within the index are assigned value or influence.
There are various methods:
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Price-weighted. Stocks are weighted based on their price per share. Higher-priced stocks have more influence. The Dow Jones Industrial Average (DJIA) is a prime example of price-weighted methods to assign a value to stock. You can also be interested in information about trading hours for Dow Jones 30 index.
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Market-capitalization weighted. Components are weighted based on their total market value. Companies with higher market caps have more influence. The S&P 500 follows this approach
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Equal-weighted. Each stock in the index holds equal importance regardless of its market cap or price. The Invesco S&P 500 Equal Weight ETF is an example
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Fundamental-weighted. Components are weighted based on fundamental factors like earnings, sales, or dividends. The RAFI Fundamental Index series uses this approach
These methods offer different perspectives on market performance which ultimately helps you in making effective trading and investing decisions.
Ethical stock market indices
Ethical stock market indices focus on companies that meet specific environmental, social, and governance criteria. These indices include companies that demonstrate responsible business practices and sustainability efforts.
One prominent example is the MSCI Global Sustainability Index, which comprises companies with strong ESG performance. Another is the FTSE4Good Index Series, which includes companies that meet globally recognized ESG standards.
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Conclusion
Stock indices can be used in diverse ways, depending on your unique financial goals. Whether you're aiming for stability, growth, or a blend of both, there's an index to match your objectives. Like any investment, stock indices are not without risk. All types of stock indices can undergo declines, and it's important to be prepared.
Before getting into the market, take the time to evaluate your financial goals and risk tolerance capacity. This will guide you in choosing the right types of stock indices to help you achieve your objectives.
Moreover, if you are looking forward to knowing about the basics of stocks, read this article: What are stocks? How do they work?
FAQs
What do stock indices mean?
Stock indices represent a specific selection of stocks used to measure the performance of a market or a segment within it.
What purposes stock indices can be used for?
Stock indices serve multiple purposes, including benchmarking portfolio performance, guiding investment decisions, and providing insights into market trends.
How are stock indices calculated?
Stock indices are calculated using various methods, such as market capitalization weighting, price weighting, equal weighting, and fundamental weighting.
What are some prominent global stock indices?
Prominent global stock indices include the S&P 500 (US), FTSE 100 (UK), Nikkei 225 (Japan), and DAX 30 (Germany), among others.
Glossary for novice traders
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Broker
A broker is a legal entity or individual that performs as an intermediary when making trades in the financial markets. Private investors cannot trade without a broker, since only brokers can execute trades on the exchanges.
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Trading
Trading involves the act of buying and selling financial assets like stocks, currencies, or commodities with the intention of profiting from market price fluctuations. Traders employ various strategies, analysis techniques, and risk management practices to make informed decisions and optimize their chances of success in the financial markets.
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Index
Index in trading is the measure of the performance of a group of stocks, which can include the assets and securities in it.
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Investor
An investor is an individual, who invests money in an asset with the expectation that its value would appreciate in the future. The asset can be anything, including a bond, debenture, mutual fund, equity, gold, silver, exchange-traded funds (ETFs), and real-estate property.
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Types of stock indices
Benchmark indices, like the S&P 500, track overall market performance; sectoral indices, such as the Nasdaq-100, focus on specific industries; market-cap based indices, like the Russell 2000, classify stocks by size; coverage-based indices span global to country-specific markets; indices by weighting method vary in how they assign component weights; and ethical indices consider ESG factors alongside financial performance.
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Team that worked on the article
Upendra Goswami is a full-time digital content creator, marketer, and active investor. As a creator, he loves writing about online trading, blockchain, cryptocurrency, and stock trading.
Dr. BJ Johnson is a PhD in English Language and an editor with over 15 years of experience. He earned his degree in English Language in the U.S and the UK. In 2020, Dr. Johnson joined the Traders Union team. Since then, he has created over 100 exclusive articles and edited over 300 articles of other authors.
Mirjan Hipolito is a journalist and news editor at Traders Union. She is an expert crypto writer with five years of experience in the financial markets. Her specialties are daily market news, price predictions, and Initial Coin Offerings (ICO).