Stock indices are one of the most important tools for traders wishing to measure the performance of markets, sectors or groups of stocks. They are a valuable way to gain insights into stock performance, trends and prices.
Market indices are closely linked with market sentiment because traders place so much intrinsic value into the data provided by indices and use this to benchmark investment choices. Indices can also offer good opportunities to traders wishing to trade CFDs and speculate on asset price movements.
With our guide, every beginner trader can understand the role of the index in stock market trading, including:
- Exactly what a stock index is
- The purpose and mechanics of indices in the stock market
- Key examples from global markets
- How stock indices can be traded or followed for insight
What Is a Stock Market Index and Why Does It Matter?
The simplest stock market index definition is that it tracks the price performance of a list of companies (stocks), either from a niche market sector or a broader perspective.
Indices vary widely in both how they are constructed and how their results are calculated. Index company lists may be compiled from a particular industry sector or more generally from those traded on a specific stock exchange. When it comes to results (‘index weighting’), some indices give every stock an equal weighting when considering overall stock index performance.
Others measure the impact using share value (‘price-weighted indices’) while market-cap weighted indices prioritise larger stocks over smaller ones when it comes to overall index performance.
With a range of indices available to provide detailed snapshots of different markets, traders can utilise this information to build a solid understanding of market trends, measure the performance of their chosen stocks, and support strategic decisions.
Major Stock Market Indices Around the World
This is a brief overview of the most followed global market indices:
S&P 500 (USA)
- Market capitalisation weighted
- Tracks the performance of 500 leading publicly listed US companies
- Covers approximately 80% of available US market capitalisation
Dow Jones Industrial Average (USA)
- One of the oldest, most respected stock market indices
- Price-weighted
- Measures daily price movements of 30 publicly traded blue-chip US companies
- More niche than other indices but provides good benchmark intel
NASDAQ Composite (USA)
- Tracks 100 of the largest and most actively traded stocks listed on the Nasdaq stock exchange
- Includes both domestic and international companies with a heavy focus on tech companies
- Market-cap weighting
- One of the most popular indices worldwide
FTSE 100 (UK)
- The Financial Times Stock Exchange Index is an index of the largest 100 UK blue-chip companies listed on the London Stock Exchange
- Most widely used UK stock index
- Market capitalisation weighted
- Constituents reviewed every quarter
DAX (Germany)
- The most important market index in Germany
- Comprised of 40 major companies whose stocks make up around 75% of the Frankfurt Stock Exchange (FSE)
- Capitalisation weighted
- Covers a wide range of industries, including blue-chip companies
CAC 40 (France)
- Comprised of the 40 most significant listed companies in France by share price based on market capitalisation from Euronext Paris, the largest stock exchange in France
- Calculated daily in real-time
- Includes many France-based corporations as well as multinational stocks
Nikkei 225 (Japan)
- Price-weighted index for the Tokyo Stock Exchange
- Includes 225 of the most prominent listed companies in Japan.
- Components reviewed biannually
- Widely respected as a benchmark index
Hang Seng (Hong Kong)
- One of the largest stock exchanges in the world and respected as a barometer for both the Hong Kong and wider Asian markets
- Comprises 82 constituent companies divided into 4 sectors, including Finance, Utilities, Properties, and Commerce and Industry Sub-indexes.
- Free-float market capitalisation-weighted index
While some of the top global stock market indices may appear focused on a single market (e.g. FTSE 100 in the UK), many stocks on many popular indices also have a major international standing, therefore this must be considered when using indices to assess regional markets.
How to Read and Interpret a Stock Market Index
Index values move in response to a change of value in constituent shares which in turn is influenced by a range of factors. These include company-specific events such as an increase/decrease in company sales or a shift in profit margins, as well as broader macro political/economic events such as policy updates or geopolitical instability. Traders will interpret index trends positively or negatively, impacting the supply/demand dynamic and the value of shares.
When deciding how to trade stock indices and best position trades in line with your outcomes, volatility should always be a major consideration, especially for beginners who may be unfamiliar with the unpredictable nature of the markets.
There are a number of potential indices trading strategies, such as trend trading. Trading with CFDs always involves a level of risk as the nature of the financial markets means that volatility can occur at any time, often unexpectedly.
Different Types of Stock Market Indices
There are four main types of stock market indices:
Broad market indices
Indices that cover a collection of large stocks to offer a broad overview of the stock market, e.g. S&P 500.
Sector indices
Sector indices such as NASDAQ-100 Tech offer insights into the performance of a select group of stocks in a specific market segment, e.g. oil and gas.
Regional indices
Represent the performance of a stock market in a specific geographical region, e.g. FTSE Europe.
Capitalisation-based indices
CAC 40 and DAX are two examples of capitalisation-based indices where constituents are weighted according to their total market capitalisation.
Each index has its own unique characteristics such as high volatility. Traders may choose to follow a particular type of index or a range of different ones depending on factors such as trading style (e.g. short- or long-term trading) and whether they wish to focus on a specific geographical region and/or industry sector.
Trading Stock Market Indices via CFDs
Traders can access stock indices through Contracts for Difference (CFDs) trading. Easily accessible to beginner traders, CFD trading involves ‘selling’ – or taking up a short position - when the asset price is predicted to fall and ‘buying’ (taking up a long position) if the asset price is predicted to increase.
CFD trading with stock indices differs from directly investing in an index fund or ETF because it involves speculating on price movements without owning the underlying asset. Leverage is a key component of CFD trading, allowing traders to access larger positions with less capital, but this type of trading on margin comes with a high level of risk.
ActivTrades offers access to trading with highly competitive CFDs on major global indices, offering investors exposure to the global markets.
Stock Market Indices FAQs
What is the importance of stock market indices?
Stock indices offer extensive insights into the performance and trends of groups of stocks in specific locations, as well as market sentiment to support an informed trading approach and risk management strategy.
Will I experience volatility when trading stock indices using CFDS?
Volatility is an inevitable part of trading in the financial markets but investing time into your trading journey and using the highest quality platforms and tools will support the best strategic approach, including optimal risk management.
The information provided does not constitute investment research. The material has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and as such is to be considered to be a marketing communication.
All information has been prepared by ActivTrades (“AT”). The information does not contain a record of AT’s prices, or an offer of or solicitation for a transaction in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information.
Any material provided does not have regard to the specific investment objective and financial situation of any person who may receive it. Past performance is not a reliable indicator of future performance. AT provides an execution-only service. Consequently, any person acting on the information provided does so at their own risk. Forecasts are not guarantees. Rates may change. Political risk is unpredictable. Central bank actions may vary. Platforms’ tools do not guarantee success.