On the 26th of May 1896, the then-editor of The Wall Street Journal, Charles Dow, got together with his statistician business associate, Edward Jones, to create the Dow Jones Industrial Average (DJIA), one of the oldest stock market indices.
To date, the DJIA still remains a highly traded financial instrument with keen interest from both Americans and non-Americans alike globally. Stock indices have been part of solid investment strategies for decades. Experts often favor these markets over picking individual stocks.
As expected, with so many countries on different continents, there are practically a gazillion stock indices to observe. Fortunately, this article will cover what we can reasonably consider the most popular of the lot and methods of investing in them.
What are stock indices?
Stock indices or indexes are financial instruments measuring the performance of a basket of multiple stocks using a particular weighting method. An index is designed to represent a certain industry or segment within the broader market.
The range of markets could be as diverse as an index like the S&P 500 (covering 500 of the largest US companies) or as niche as the Dow Jones US Technology Index (tracking the performance of a handful of tech-based American corporations).
Analysts categorize stock indices namely through the following groups:
Each index is calculated according to a specific weighting method to determine its price. Common calculation models include market-capitalization, free-float adjusted market-capitalization, price, equal, fundamental factor, factor, volatility, minimum variance weightings, or some combination of these.
The benefits of stock indices
Trading indices over individual stocks provides numerous benefits. For starters, it’s easier to be well-diversified within a particular sector. Rather than buying all or some of the stocks of the 500 corporations in the S&P, you’d only make one simple purchase.
If you wanted specific exposure to the tech industry, you could merely invest in the NASDAQ-100 Technology Sector index.
By doing so, you’d save a lot of time analyzing the many individual shares and performing due diligence. Consequently, your trading costs would also be lower. Also, most experts consider indices as less volatile than single stocks, meaning they are technically not as risky.
On the downside, the higher volatility of numerous single stocks can provide you with much better returns comparatively.
List of the most popular stock indices
Now that we’ve covered a bit about what indices are and their benefits let’s explore which are the most popular markets in this realm.
S&P 500 (^GSPC, $SPX, INX, US500, or USA500): Created in 1957, the S&P (Standard & Poor’s) is the largest stock index globally. The index tracks the performance of the most valuable 500 American corporations using the free-float capitalization-weighted method.
Companies forming part of this instrument are listed on either the New York Stock
Exchange (NYSE), Investors Exchange, NASDAQ, or the BATS Global Markets.
The S&P is maintained by S&P Global, a US-based credit rating agency and index provider. Along with the DJIA, many experts use the S&P as a benchmark of the overall health of the US stock market.
Nasdaq Composite (^IXIC): This stock market index includes almost all the 3500+ stocks on the NASDAQ exchange. IXIC is a closely followed market in the United States and the globe at large.
Created in 1971, the NASDAQ Composite consists of almost 50% information technology corporations. Hence, it’s a yardstick for the performance of this sector within America. The index uses the market capitalization weighting calculation similar to the S&P.
Dow Jones Industrial Average (^DJI, $INDU, DJI, or DJIA): The DJIA (or simply the Dow/Dow Jones) is a price-weighted stock index operated by the S&P Dow Jones Indices.
This index measures the performance of 30 large-cap blue-chip US stocks (including the likes of Apple, Microsoft, Walmart, etc.) listed on the NASDAQ and NYSE.
A long time ago, the term ‘industrial’ had previously focused on companies within the heavy industry segment. However, nowadays, stocks from many sector types form part of the DJIA.
Financial Times Stock Exchange 100 (UKX or FTSE 100): The FTSE 100 or the ‘Footsie’ is a capitalization-weighted stock index consisting of the top 100 large-cap shares listed on the London Stock Exchange Group (LSEG).
It was created in 1984 and is now managed by the FTSE Group, which itself is a subsidiary of the LSEG. Like the S&P, investors consider the Footsie as a broad indicator of the UK’s overall economic health.
DAX (GER40): The DAX (Deutscher Aktien Index) is another popular capitalization-weighted equities index comprising the 40 blue-chip corporations listed on Germany’s Frankfurt Stock Exchange.
Up until November 2020, the DAX had historically consisted of 30 companies. The DAX was established in 1988 and is now operated by the Deutsche Börse Group. As Germany’s largest stock index, it’s used as a gauge of the overall domestic market within this country.
Nikkei 225 (NI225 or JPN225): The Nikkei 225 or Nikkei is a well-known price-weighted stock index covering 225 companies listed on Japan’s Tokyo Stock Exchange.
The name is derived from Japan’s flagship newspaper publication Nihon Keizai Shimbun, which simply means ‘Nikkei.’ Since the index’s inception in 1950, the Nikkei 225 has been operated by the same Japanese newspaper.
Like many other country-based indices, Nikkei’s performance provides a broad overview of Japan’s economy as a whole.
Like most instruments, several methods exist for trading or investing in stock indices. The most popular is through spot derivatives. Here you take no ownership of the underlying asset. The leverage is relatively high. You can buy and sell and have widespread accessibility with brokers.
Other well-known forms of derivatives for stock indices include futures and options, which also provide similar benefits.
However, these avenues are mostly geared towards speculators. Those with more of a slower, buy-and-hold approach might instead consider investing in index funds that have been lauded as a tried-and-tested passive income investment.
Overall, stock indices provide numerous advantages such as comprehensive market exposure or diversification and low transaction costs. It’s not to say one shouldn’t consider individual stocks as these can produce better gains. However, stock indices have long been perceived as safer bets.