A.10. Market Indexes

A market index is a number calculated from, and intended to measure changes in, the market price for a group of securities, for securities traded on a specific stock market, or for an industry segment. (You might see the plural spelled as either “indexes” or “indices.”) If you can imagine a market, industry sector, or type of security, chances are someone has developed an index to track the performance of that item.

The typical market index tracks the ups and downs of a basket of securities, usually stocks, that are supposedly representative of the market or segment of interest. A broad-based index tracks many stocks and is intended to represent the performance of the overall market. Narrowly based indexes track specific industry or market sectors.

Indexes must be weighted, and there are different approaches to this process. Some indexes are price-weighted, meaning the price of the constituent stocks is the sole factor that determines the index value. In price-weighted indexes, a sharp rise or fall in the price of a single stock can affect the index value significantly. Other indexes use a capitalization-weighted or market value–weighted approach, in which companies with a larger market cap have a greater influence on the index value. Still other indexes use hybrid measures to determine index value. Every index weighting approac