Market Discussions

If I had to describe my understanding, I've gone from not knowing what I'm doing, to sorta kinda maybe knowing a little tiny bit but not really.

So, can somebody explain what a market index is to me?

It's an average of a bunch of different prices. One of the oldest market indexes is the Dow Jones Industrial Average, which is basically the average of 30 representative companies.

Of course choosing which prices you choose to average (the basket), the weight you give to each one, and how you adjust the averages when you change which ones are in the basket are all important issues that are not usually considered by the typical user.

For example, the DJIA is price weighted. Higher priced stocks count for more than lower priced stocks. Also when they remove a failing company from the average and replace it with a stronger company, they have to adjust a muliplier that keeps the trend consistent, but also tends to make the average rise over time (because the stock you are replacing will most likely have a lower price than the one that replaces it.) Also, stock splits increase the multiplier.

Standard & Poors 500 is equity weighted, which means that larger companies count more toward the average than smaller companies. Both methods have their advantages and disadvantages.