A stock index is a compilation of individual stocks used to aggregate the performance of the entire stock market or some specific sector. The purpose of this index is as a comparison in the returns of various investments. Most indices use a weighted average to give larger companies more sway in the index. The Dow Industrials, the S&P 500 and the Nasdaq are examples of U.S. stock indices.
Stock Index Types
There are many types of stock indices. Some are meant to represent the performance of an entire country’s equity markets. The S&P 500 is like that. It is meant to represent the performance of large U.S. corporations. Another index, the Wilshire 5000, includes nearly all listed stocks from major exchanges and is a gauge of the performance for the entire U.S. equity universe.
There are indices meant to track certain types of stocks, such as small-cap stocks, mid-cap stocks, value stocks, and growth stocks. Other indices track the performance of individual sectors. For example, the S&P 500 Energy Index tracks the performance of the energy sector, while the S&P 500 Information Technology Index tracks the performance of technology stocks.
As mentioned above, most indices are price-weighted, so they give more weight to stocks that have higher prices. As an example, if there was an index made up of five stocks with prices of $35, $25, $20, $12, and $8 the $35 stock would make up 35% of the index, and the $8 stock would make up 8% of the index, no matter the size of the respective companies. The Dow Industrials is a price-weighted index.
In a market capitalization-weighted index they weight each stock based on the market capitalization of the companies. The S&P 500 is a market capitalization-weighted index. Because companies like Apple and Amazon are so large they make up a large portion of the S&P 500.
There are also equal weight indices where each company has an equal weighting. So, if there are 100 companies in a hypothetical equal weight index, each would contribute 1% of the index total.