1.11 STOCK INDICES
The aim of a stock index is to convey a sense of the market's movements in a single number. As a result, observing market indices has become part of every investor's daily life. Probably the single most quoted index is the Dow-Jones Industrials Average, which is an index of 30 stocks listed on the NYSE. Broadly speaking, an index can be differentiated along two important dimensions: first, the set of securities it consists of, and second, the relative weighting scheme used to construct the index number.
The Dow Jones Industrials
The Dow Jones index was started in 1884 by Charles Dow and Edward Jones in a newsletter that eventually became the Wall Street Journal. Initially, the index was the sum of the stock prices of 11 companies divided by 11. Since then, the number of companies has increased to 30, and the divisor has been adjusted for stock splits, mergers, and additions to and deletions of firms from the index. In any of these cases, the divisor is changed so that the index value before the event (e.g., a split) equals that after the event.
The S&P 500
The S&P index, established by Standard & Poor's Corporation, is a value-weighted index of 500 companies, mostly listed on the NYSE, but also including some large OTC stocks. The index had a base value of 10 in 1941-1943. The index is calculated using the formula
where V(t) is the total market value of the 500 stocks in period t, and V(0) is the total market value in the base period (1941-1943).
The NYSE Composite
The NYSE composite index is computed in the same way as the S&P 500, and includes all stocks listed on the NYSE. It had a base value of 50 in 1965.
The Nasdaq Composite
The Nasdaq composite index is computed in the same way as the S&P 500, and includes all over-the-counter stocks. It had a base value of 100 in 1971.
The FTSE 100
The FTSE 100 is a value-weighted index of 100 major stocks traded on the London Stock Exchange. FTSE stands for "Financial Times Share Index," issued by the Financial Times newspaper.
The Nikkei 225
The Nikkei 225 index, of 225 major Japanese stocks, is an arithmetic average similar to the Dow Jones Industrials.
The TOPIX index is a value weighted index of the 150 First Topic stocks on the Tokyo Stock Exchange. It is computed in a manner similar to the S&P 500 index.
You can learn about the rules by which securities are traded in the topic Trading in the Markets.
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