What Is an Index?
An index boils a basket of stocks down to a single number. It's the market's thermometer.
Concept clip · An index: the market's thermometer
About 25 s · Watch first, then try it
Key takeaways
- 1An index measures the overall rise and fall of a group of stocks, such as the S&P 500 or the CSI 300.
- 2Index points aren't a price; they show change relative to a base date. % change = change in points ÷ previous points.
- 3Indexes rebalance their constituents regularly and can represent a whole market, a sector or an investment style.
- 4Common price indexes exclude dividends; one that counts reinvested dividends is a total return index.
Check your understanding
Get every question right to complete this lesson
1.An index rises from 4,000 to 4,400 points. What's the gain?
2.What is an index mainly used for?
3.An index started at a base of 1,000 points and is now at 2,500. How much has the basket risen overall since the base date?
Text version · Indexes & ETFs, lesson 1: “What Is an Index?”
An index boils a basket of stocks down to a single number. It's the market's thermometer.
A basket of stocks → one number
An index combines the moves of a group of constituents, by weight, into one number. One look tells you whether the market as a whole is hot or cold.
Points are just a scale relative to the base
An index level isn't a price. One day is set as the base (say 1,000 points), and later levels only show how much it has risen or fallen since then.
Constituents change regularly
An index isn't a fixed list. A regular index rebalance drops companies that no longer qualify and adds new ones. So an index represents "the market today", not a fixed set of companies.
Price index vs total return index
Most index levels only track prices and leave out dividends; one that includes reinvested dividends is a total return index. Over time the two drift far apart (chart is illustrative).
Key takeaways
- An index measures the overall rise and fall of a group of stocks, such as the S&P 500 or the CSI 300.
- Index points aren't a price; they show change relative to a base date. % change = change in points ÷ previous points.
- Indexes rebalance their constituents regularly and can represent a whole market, a sector or an investment style.
- Common price indexes exclude dividends; one that counts reinvested dividends is a total return index.
Try it yourself
You can do these exercises in this lesson's interactive simulation:
- Click "Example: 4,000 → 4,400": the index rose 400 points. What's the percentage gain?
- Switch the market to "Still" and push Galaxy Tech (30% weight) up 10%: how much did the index rise?
- Now push Green Sprout Foods (15% weight) up 10% and compare the two index moves: why are they different?
- Switch back to "Random daily moves" and play to day 60: with 5 stocks going up and down, is the combined index up or down?
Quiz and explanations
- 1. An index rises from 4,000 to 4,400 points. What's the gain?
- Answer: 10%.400 ÷ 4,000 = 10%.
- 2. What is an index mainly used for?
- Answer: Measuring the overall performance of a basket of stocks.An index is a yardstick for the market.
- 3. An index started at a base of 1,000 points and is now at 2,500. How much has the basket risen overall since the base date?
- Answer: 150%.(2,500 − 1,000) ÷ 1,000 = 150%. The points themselves aren't a price; they only show how far it's risen from the base.
Terms in this lesson
- constituent (Constituent): A stock included in an index's calculation.
- index (Index): A single number that tracks how a basket of assets is doing overall, such as the S&P 500.
- index rebalance (Index Rebalance): An index's regular review that removes companies that no longer qualify, adds new ones and resets the weights.
- total return index (Total Return Index): An index that also counts reinvested dividends from its constituents; one that tracks only price changes is a price index.