Chapter 1 – What are the markets?
(This is the 1st lesson on a series of preview chapters on a course that is due to be released soon. Please read the disclaimer before proceeding. If you found this lesson useful, don’t hesitate to share it and please follow us on all our social media for more updates!)
Outline of today’s lesson, we will be covering:
- What are the markets?
- How does an index works?
- Why is the index useful?
- Indexes from around the world
- Where to view indexes?
- Sum up the lesson
What are the markets?
When we talk about markets in this sense, we are referring to the stock market. Every country have their own stock market, a stock market is a market where stocks can be traded. To see how the stock markets are generally doing, we will look at the index. (*In this lesson, when I refer to index, I am referring to major world indexes.)
An index shows the change in price for a selected group of stocks.
How does an index works
Think of a scenario where, we are at a furniture store owned by Mike. This furniture store sells 2 kinds of chairs, chair A and chair B. We have this index that tracks the pricing of the 2 different chairs in Mike’s shop.
Looking at an example
Every time Mike increases the price of one of his chair by $1, the index goes up by $1. If Mike reduces the price by $1, the index goes down by $1 as well.
Let’s say today Mike decides to increase chair A’s price by $5 today and decrease chair B’s price by $2. The index will register an increase of $3.
|Chair A||Chair B||Index|
Tomorrow Mike decides that he wants to decrease chair A’s price by $4 and decrease chair B’s price by $2. The index will then drop by $6.
|Chair A||Chair B||Index|
This is similar to how it works for a stock market index. It will register all the changes in price for all the stock that it covers and let you know if the overall day is positive (more stock prices went up) or negative (more stock prices went down). Of course the calculation is not as simple as there are more than 2 stocks in the index and changes in stock pricing for certain stocks affect the index different as some stocks have a higher weightage.
Why is the index useful?
An index does not represent all the stocks in the market, it only covers certain stocks that are chosen. So what is the use of looking at the index?
The stocks selected to be in the index are normally very large companies from different sectors of the market. Their combined value makes up a good portion of the entire stock market. Thus the index is useful because it acts as a good benchmark for the overall markets and you can quickly see how the overall market is doing.
Looking at an example
There are 4 stores in Mike’s neighborhood called Town A. One of the stores belongs to Mike. There are 2 clothes stores and the last store sells bread.
Let’s say you want to know, is the sales in Town A good?
An index consisting of Mike’s store and both clothes stores will give a good representation of the total sales in Town A.
Indexes from around the world
Many stock markets around the world also have their own index. Some examples of world indices are Japan’s NIKKEI 225, London’s FTSE 100 and in the US we have the DJI and S&P 500.
Examples of US indexes
For the US, one of the most famous indexes is the DJI or Dow Jones Industrial Average, which comprised of 30 stocks that are very large and influential in their industry.
We can also look at the S&P 500, which consists of 500 of the largest companies in the US. But for a stock to join the S&P 500, it has to pass certain criteria like having a market cap of at least $5.3 billion, 4 straight quarters of positive earnings and at least half a year since its initial public offering. There are more criteria, you can read on if you are interested.
Basically, all these companies are big companies and are doing quite well. The S&P 500 also captures roughly 80% of the available market cap.
Where to view indexes
There are many ways to view indexes. You can do a simple Google search for major indices, many websites will show these. One way is to use Yahoo Finance. It shows many of the major indices in the world and by clicking on them you can see the summary and even look at the components that make up some of the index.
I prefer to use the Singapore version of Yahoo as I am only interested in the major indices in the US and well, that’s where I’m from!
To sum up this lesson
- An index will show the change in price for a selected group of stocks.
- An index is a good benchmark and looking at the index gives you an overview of how a market is doing.
- Most stock markets around the world have their own indexes, which will track their own markets.
- There are plenty of websites where you can view indexes, Yahoo Finance is one of them.
More info for those who are interested
These are just for those who want to get a better understanding of the different weighted index and how they are calculated.