Understanding Stock Market Indices- What Stock Market Indices Tell About The Market – Part III

Other important global stock market indices

FTSE 100

This index covers stock of 100 most capitalised UK companies listed on the London Stock Exchange. The index is a market value weighted index and is calculated by a method called free float method. Market value (which is price of stock multiplied by the number of shares)is multiplied by the free float factor and then divided by the index divisor to arrive at the index. The Free float Adjustment factor is the total number of shares that is floated as a percentage of issued shares round off to the nearest multiple of 5%.

CAC40

This is the most widely used index for tracking stocks on the French stock market. As the name suggest the index includes 40 most capitalized French companies listed on the Paris stock exchange. Like all other major stock indices this is also a market weighted index.

DAX

This index tracks the stocks of 30 major German companies in terms of market capitalization trading on the Frankfurt stock exchange.

Nikkei 225

Nikkei 225 is the most widely quoted stock market index of the Tokyo stock exchange. Like Dow Nikkei 225 is a price weighted index whose components are reviewed on a yearly basis. Equal weighting is given to all stocks based on a par value of 50 yen per share. There is no specific weighting for industries.

BSE Sensex

The index is a value weighted index of 30 largest and most actively traded stocks on the Bombay Stock Exchange.

Nifty

Again covering the Indian Market, the index covers 50 large companies in 21 different sectors traded on the National Stock Exchange.

Hang Seng

This market capitalization weighted index monitors the performance of stocks of 45 largest companies traded on the Hong Kong Stock Exchange.

Problems with Indexes

Overall indexes provide a good indicator of investor mood and overall economic climate. However like any other financial parameter they have few flaws owing to their design. One of the biggest problem with indexes is that it is prone to subjective error cause stocks to be included and stocks not to be included is determined by people and hence is subject to error. Also putting weights by size tends to make the index quite volatile. A bad day in just one big company can shake the whole index and give a wrong picture that the market and the economy is in trouble.

Hence there are few things that investors should keep in mind when they are taking decisions based on index. First of all index just represent a set of stocks. Hence they are part of market not the whole market. It is important that as an investor one should understand the fundamentals of the stock you are interested in and trust your analysis. Use index as one of the determining factor not the sole determining factor.

Secondly if you are one who focuses on minute by minute or hour by hour indexes then you are doing nothing but wasting your time. At most track the opening and closing volume to get an idea of how the trading day has been.

Lastly indices are useful in understanding historical trends. They may provide a clue on the future behaviour but it is better not to use them for forecasting.

Read more at: Understanding Stock Market Indices- What Stock Market Indices Tell About The Market – Part II