Share indices help to impose order on this array of investment opportunities. They act as benchmarks against which to trade, as well as a barometer of the economic and political climate of the day.

Not all indices are the same size, or are compiled in a similar way, but each will have a criteria for the stock it lists. Stock Exchanges have a range of indices, and what index a share is listed on can tell us a lot about that particular share.

Many countries have their own stock exchange which will typically include their own main index: for example, the UK’s FTSE 100, Germany’s DAX and Japan’s NIKKEI. Two leading indices are commonly quoted for the United States. These are, New York Stock Exchange’s Dow Jones Industrial Average (or Dow) and Standard & Poors’ S & P 500.

The NASDAQ Stock Market is also based in New York, and its NASDAQ Composite Index is a leading indicator for the performance of technology stocks. This index includes all those companies listed on the NASDAQ exchange and so currently includes nearly 2800 companies. Many of the companies listed are included in other exchanges across the world, so, despite trading in New York, it is not exclusively an indicator for US companies.

Within a stock exchange there are likely to be a range of additional indices covering different size companies. (The size, or overall stock value, of a given company is called the market capitalisation and is a multiple of the total number of share issued and their individual value. Companies are sometimes broadly defined as large-, mid- or small-cap (short for capitalisation) depending on their size, however definitions tend not to be exact.)

The London Stock Exchange, for example, has an all-share index which covers all listed shares meeting a certain criteria. Its main index, the FTSE 100, covers the 100 listed companies with the largest market capitalisation. In addition there is a separate index covering the next 250 largest companies called the FTSE 250. These two indices combine to form the FTSE 350, and the remainder make up the FTSE SmallCap index.

The main index for a given exchange will generally consist of a number of companies with the highest market capitalisation trading on that exchange, although the number of companies an index covers can vary widely. For example, the S & P 500 (as its name suggests) covers 500 large-cap companies trading in the USA, whereas the German DAX covers the 30 companies with, broadly speaking, the highest values which are traded on the Frankfurt Exchange.

Indices are most commonly compiled in a way which gives greater weighting to price movements of larger companies’ stock (i.e. those with the highest market capitalisation). They are known as capitalisation-weighted indices.

Some indices do work in a different way. The Dow and Japan’s Nikkei 225 are indices composed of large-cap stocks, but calculate their values as an average of the sum of stock prices divided by number of stock. This means that it is the price of each share, not market capitalisation, which is significant for the index. For example, a given percentage price movement of, say, a $20 share will have a greater bearing on the movement of the index than that of a share trading at around $5, irrespective of market capitalisation. This is known as a price-weighted index.

What index a company is listed on can tell an investor much about that company. For example, a share listed on London Stock Exchange’s AIM (Alternative Investment Market) is likely to be a far more speculative investment that one listed on the FTSE 100. Whilst part of the main London Stock Exchange, the AIM index is separate to the FTSE All-share index and is an international exchange for smaller businesses looking to raise capital for growth.

As index movements are often studied in their own right to follow and predict trends in the market, equity indices are clearly far more than just a sum of their parts and, as such, they are a very useful tool for investors.