If you’re into investing and you follow news every day, you
would be familiar market indexes. You encounter these indexes every day: when
you read the news, watch the TV, listen to the radio, and surf the net.
For one, we’re sure you’ve heard about the NYSE, NASDAQ,
FTSE, and others. These names pop up every day when news anchors and news
websites give updates about the market.
However, not everybody is aware of the real functions of
these exchanges. Most of the time, they only know that these indexes are going
up or going down.
In this article, we’ll give you a quick introduction to what
market indexes are and what purposes they serve.
Market Indexes: What are
they?
Market indexes serve as statistical indicators. They are
made to make it easier for people to compare the performance of a pool of
securities. And such pool of securities can stand for an entire market or a
specific part of the market like banks, oil, and others.
The index doesn’t have to include all the companies found in
the market. Instead, the index only tracks a handful of companies that broadly
represent the performance of the whole market, which can be gauged through their
performance.
Read further, Stock Market Index: A Complete Beginner's Guide
The Purposes of Market
Indexes
Indexes serve many purposes. Here are some of the most
important things that indexes provide market participants.
Monitoring
This is perhaps the biggest purpose that indexes serve. They
are used to track or monitor the movements of the stock market, whether it’s
going up, down, or sideways. All movements are anchored on the same base year
and base value.
And because of that, you can easily compare the movements
much easily. In fact, that’s the reason why indexes have become the most common
way of tracking the movement of stock prices around the world.Using them this way helps a lot when it comes to technical analysis.
However, the movement in one index cannot be definitively
compared to the movement tracked by another index. Therefore, there’s no such
thing as an inter-index comparison.
Benchmarking
Indexes also tell investors something about the stock’s behavior
in comparison to the overall market performance. This paves the way for the
easier benchmarking of a stock’s performance. You have to know both the growth of
the stock and the growth in the relative index if you want to know whether the
stock has outperformed others.
If the stock grew 20 percent, and then the index grew 25
percent, it cannot be said to have outperformed the market. Instead, it would
be tagged as a weak performance.
Risk Gauging
The value that you get from the indexes is a crucial part of
determining the riskiness of a stock. And a stock can be riskier or less risky
in comparison to other stocks in the market.
You can gather the data that can be compared to the risk of
the stock along with the indexes. The data you get can then be converted into “beta,”
which is a universal statistical measure of riskiness.
Derivatives
The indexes also served as the basis from which derivative
contracts are drawn. You can’t manipulate index movements, and that means
derivative traders can base the contracts on these indexes.
Conclusion
You may think that you know what market indexes are.
However, they can be more complex than you think. For now, the most important
thing you have to keep in mind is that indexes can be used various ways to help
you understand the market deeper and better.
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