Index

Stock trading dictionary: meaning, example and how traders use it.

Last updated: October 17, 2026

Definition: An index is a statistical measure that tracks the combined price performance of a defined group of securities, such as the S&P 500, the Dow Jones Industrial Average, or the Nasdaq Composite, and is used as a market benchmark.

How a stock index works

An index provider selects a basket of stocks using published rules, such as company size, listing exchange, industry, or liquidity, and then calculates a single number that rises and falls with the basket. The value is usually set to a round base figure on a starting date, so later readings show cumulative change rather than a dollar amount anyone paid.

Well-known US examples include the S&P 500 (large US companies), the Dow Jones Industrial Average (30 large companies), the Nasdaq Composite (most stocks listed on Nasdaq), and the Russell 2000 (small companies). There are also indexes for each stock sector, for bonds, for commodities, and for foreign markets.

How indexes are weighted

  • Market-cap weighted: each company's influence is proportional to its market capitalization. Most major indexes, including the S&P 500, use this method, usually adjusted for freely tradable shares (float).
  • Price weighted: higher-priced shares carry more weight regardless of company size. The Dow uses this approach.
  • Equal weighted: every member counts the same, giving smaller companies more influence than in a cap-weighted version.

Weighting matters. In a cap-weighted index, a few very large companies can drive much of the return, while an equal-weighted version of the same stocks may behave quite differently.

Example of index calculation

Suppose a simple cap-weighted index holds three companies with market values of $600 billion, $300 billion, and $100 billion, for a total of $1 trillion. Their weights are 60%, 30%, and 10%. If the largest stock rises 5% and the other two are unchanged, the index rises 0.60 x 5% = 3%. If instead the smallest stock rises 5%, the index gains only 0.5%.

Real indexes use a divisor that the provider adjusts for stock splits, additions, deletions, and share changes, so these events do not create artificial jumps in the index level.

How investors use indexes

Benchmarks: fund managers and individual investors compare their portfolio returns with a relevant index. Returns above the benchmark after adjusting for risk are called alpha, and sensitivity to the benchmark is measured by beta.

Index investing: you cannot buy an index directly, but index mutual funds and ETFs aim to replicate one at low cost. Index futures and options are used for hedging and trading.

Market gauges: news reports use major indexes to describe whether the market is in a bull market, a correction, or a decline.

Limitations of indexes

An index reflects its rules, not the whole economy. Price-only versions ignore dividends, so total-return versions are better for long-term comparisons. Concentration in a few large companies or one sector can make a broad-sounding index less diversified than it appears.

Frequently asked questions

What is the most widely followed US stock index?

The S&P 500 is generally viewed as the main benchmark for large US stocks, while the Dow Jones Industrial Average is the oldest widely quoted average.

Can you invest directly in an index?

No. You invest through index funds or ETFs that hold the index's stocks, or through derivatives such as index futures and options.

What is the difference between price-weighted and market-cap-weighted indexes?

A price-weighted index gives more influence to higher-priced shares, while a cap-weighted index gives more influence to companies with larger total market value.

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For information only, not investment advice. See the disclaimer.