Market index definition

What is a market index?

A market index is a benchmark that tracks the price movements of a group of different company share prices and other assets. The companies are often grouped according to size, industry and geographic location – and each company is given a ‘weight’ in the index according to a specific methodology.

Some people will sometimes use ‘indexes’ as the plural of index – but this is more applicable to written documents or bibliographic references. In the finance world, you’ll often hear the plural ‘indices’.

 

Market index methodologies

There are a few different ways that market indices can be calculated, and we’ve included some of the most common below. Different methods of index weighting will give companies more or less influence over an index’s value depending on various factors.

Here are some examples of the most popular market index weightings.

 

Market-capitalisation weighted indices

A market-capitalisation (market-cap) weighted index puts more weight on companies with larger market capitalisations.

A market-cap weighted index will include ‘closely held’ or ‘locked-in’ shares. These are shares owned by the government, company officers or controlling-interest investors. Put simply, this method of index weighting includes the total number of a company’s shares, not just those that are available to the public.

 

Free-float adjusted market-capitalisation indices

A free-float adjusted market-cap index is similar to a standard market-cap weighted index, but it only includes shares that are readily available to the public – hence the name ‘free float’, meaning the shares that are freely trading on the market. 

As a result, it’s different to a regular market-cap weighted index, which will also include ‘closely held’ or ‘locked-in’ shares. 

 

Price-weighted indices

In a price-weighted index, companies are given more weight according to the company’s current share price. So, companies with higher share prices have more influence over an index’s value – regardless of the company’s market-cap.

 

Equal-weighted indices

An equal-weighted index gives each company the same influence over an index’s price, regardless of the company’s market-cap or current share price. Equal-weighted indices can be more equally diversified than market-cap weighted indices, but they are also more vulnerable to the effects of bear markets.

 

Market index examples

Here are some examples of different market indices to help you get to grips with what they track.

• The FTSE 100 is an example of a market-cap weighted index. It tracks the price movements of the 100 largest UK-listed companies including AstraZeneca, Barclays and Unilever.
• The S&P 500 is an example of a free-float adjusted market-cap index. It tracks the 500 largest companies in the American market including Microsoft, Tesla, JPMorgan Chase & Co and Disney.
• The Dow Jones Industrial Average (the Dow) is an example of a price-weighted index. The Dow tracks 30 prominent companies listed on US stock exchanges including 3M, Coca-Cola, IBM and Nike.