By Sagar Maheshwari December 23, 2020

What are the equity indices?

Equity indices is a statistical indicator that shows variations in the financial market value of a specific group of stocks or shares. Sometimes it is also known as a stock index or indexes.

There are various kinds of equity indices, based on measurement criteria such as:

The averaging method employed for establishing the indices

The coverage base

The method through which the averaging methods attributes index weights

Thus, in reality, equity indices are not similar, and they may display diverse behaviour.

Why are stock indices required?

The equity market indices are similar to a barometer, indicating the conditions of the entire financial market. They allow traders and investors to determine the general pattern of the equity market. The various advantage of equity market indices are as follows:

1) Helps in deciding the stock for trading

Deciding the best stock for trading in the equity market is a hard nut to crack. Hence, stock indices help classify the firms and their stocks by considering the key characteristic that includes the sector, type of industry, and size of the firm and several others.

2) Behave as a representative

Investing in the stock market brings along several risks, and thus, it is important to make an informed decision. Your trading decision should always lie on facts rather than predictions. Indices serve the purpose and fill the gap of knowledge that exists among the traders. They display the trend of the entire stock market or a particular sector of the financial market.

3) A financial instrument for comparing stocks

Before adding any stock to your trading portfolio, you must compare it with the underlying asset. Stock market indices act as a financial instrument, though, which you can compare various stocks.

Narrow-based and broad-based indices

It characterizes indices as per coverage and stock representation. The representation can be a particular group of firms with specific features. On the other hand, coverage can be national, global, or industrial. To understand more, we can take the example of Dow Jones Indices. The Dow Jones total equity market index for a global measure is a broad-based index, regarded as a complete reflector to the global equity market.

Different types of equity indices by coverage

Equity market indices can be segmented and divided by considering the index coverage set of shares. The coverage of the index refers to the underlying group of stocks. It generally segregates depending on their underlying n investor demand or underlying economics that the indices attempt to track or represent.

For instance, a global or world share market index such as S&P Global 100 or the MSCI World includes all shares across the world. It satisfies the demand of traders for a broad global stocks index.

Regional indices are the ones that make the MSCI World index (MSCI emerging markets index). It includes shares from those countries which have the same level of economic condition and development. It also satisfies traders’ demand for an emerging markets stock index that may come across the same economic fundamentals.

Both the weighting method and coverage of the share market index are independent. For example, the famous market-cap weighted index S&P 500 includes about 500 biggest shares from the S&P Total Market Index. Moreover, it also equally includes the weight S&P 500 index with the same level of coverage.

1) Global coverage:

Global coverage describes the performance of the worldwide stock market. The FTSE global equity indices series incorporates over 16,000 firms.

2) Regional coverage:

Regional coverage describes the performance of the equity market of a geographical region. Some examples of these types of indices are the FTSE Developed Asia Pacific Index and the FTSE Developed Europe Index.

3) Exchange-based coverage:

Exchange-based coverage indices may be dependent on an exchange, such as groups of exchanges (OMX Nordic 40 or Euronext 100) and NASDAQ-100.

4) Sector-based coverage:

These equity indices check for the performance of a particular sector of the financial market. Some of its examples are the NASDAQ Biotechnology Index that comprises approximately two-hundred companies in the biotechnology sector, and the Wilshire US REIT Index, which keeps track of more than eighty real estate investment trusts.

5) Country Coverage:

The country coverage index describes the performance of a nation’s share market and reflects the trader sentiments on the condition of its economy. The commonly quoted market indices include the national indices. It comprises shares of big firms listed on the largest stock exchange of the nation. The indices are Nikkei 225 of Japan, the NIFTY 50 of India, S&P 500 index of the United States, DAX of Germany, FTSE 100 of the United Kingdom.

Other indices may trace firms of a particular type of management, a particular size, or more functional criteria, including fundamentally based indexes.

The Bottom Line

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