A stock or equity index is a "basket" of stocks designed to reflect the composite value of its underlying stocks. Because it can be difficult for investors to accurately select and invest only in the top-performing stocks, using financial products (e.g., exchange-traded funds, futures, options) that track stock indices -- which provide exposure to the whole market or a sector of the market rather a few individual stocks -- has become increasingly popular since they were first introduced in 1982 (with S&P 500 stock index futures) at the Chicago Mercantile Exchange and in 1983 with the S&P 100 Index options (OEX) at the Chicago Board Options Exchange. Other tradable groups of securities like commodities or regional markets often have their own tracking index that can also be traded like a stock index.
Each stock index's component stocks bear some common traits: they may trade on the same stock exchange, belong to the same industry, or have similar market capitalizations. Many indexes compiled by news or financial services firms are used to benchmark the performance of portfolios. Globally, Dow Jones, Standard & Poor's and Russell are among the best known of these organizations. The Nasdaq Stock Market also has licensed a number of indexes based on various underlying groups of stocks, which have become well known and successful.
Securities based on broad-based indexes allow investors to effectively own the same basket of stocks contained in a major index while committing a smaller amount of financial resources. By viewing a stock index, it's also a simpler matter to track how stocks perform overall without having to look at each stock individually and make an assessment.
The most regularly quoted market indexes are broad-based indexes ased on the stocks of large companies listed on a nation's largest stock exchanges, such as the Dow Jones Industrial Average, S&P 500 Index, the British FTSE 100, the French CAC 40, the German DAX, the Japanese Nikkei 225 and the Hong Kong Hang Seng Index.
Note, however, that many indexes themselves are traded on exchanges other than stock exchanges, e.g., futures and security options exchanges, which have a huge stake in the success of indexes and have been highly rewarded for their foresight in introducing these products. Chicago Mercantile Exchange in 1982 introduced the first stock index futures contract -- S&P 500 futures -- and the Chicago Board Options Exchange answered with the CBOE-100 index options (now the S&P 100 options contract, known as OEX) a year later. Thus, futures and options exchanges now vie for interest in these products.
Not all stock indexes are categorized by an exchange on which trading is offered. The Dow Jones Wilshire 5000 Total Stock Market Index, as an example, represents the stocks of nearly every publicly traded company in the U.S., including all U.S. stocks traded on the New York Stock Exchange (but not American Depositary Receipts or ADRs) and most traded on NASDAQ and American Stock Exchange. The Europe, Australia, and Far East Index (EAFE), published by Morgan Stanley Capital International, is a listing of large companies in developed economies in the Eastern Hemisphere. Russell Investment Group added to its extensive index listing in early 2007 with the launch of the Russell Global 10000; it covers 80 countries and all stocks with a market capitalization greater than $200 million USD.
Specialized indexes also track performance of specific sectors of the market. For example, the NASDAQ Biotechnology Equal Weighted Index is an equal weighted index based on the top 100 securities (by market value) of the NASDAQ Biotechnology Index. The Morgan Stanley Biotech Index consists of 36 American firms in the biotechnology industry. The S&P GSCI provides investors with a publicly available benchmark for investment performance in the commodity markets.
Indexes also are classified by the method used to determine their respective price. Price-weighted indexes specify that the price of each component stock is the sole consideration in determining index value. A capitalization-weighted (or market-value weighted) index, in contrast, considers in the size of the company in the index'es pricing. In a market-share weighted index, price is weighted relative to the number of shares, rather than their total value.