Stock index is the compilation of stocks. That compilation aims to track a particular asset, not only the market, but also a commodity, bond, currency, and sector.
The collection of stocks in an index called a basket. For instance, when you want to invest in the DIJA (Dow Jones Industrial Average Index), then you will purchase shares of the stocks in the index basket.
That means you own the shares of 30 different companies.
How does it work?
We can utilize the index to track a particular asset or market. For instance, the Gold and Precious Metals Index (XAU) consists of various companies mining gold and other precious metals.
Then, if you buy the stocks in the index, you get exposure to the gold mining sector. However, you do not need to buy shares in every single gold mining company in the world.
Your shares in XAU are representative of the gold mining industry as a whole.
The Weighting
The weighting represents the process of an index basket allocated. A price-weighted index can have different amounts of shares in each stock basket. The amounts of that division are based on price. For instance, a stock worth $30 will have 1 share, where a stock worth $5 will have 6 shares.
Other than that, there is also weighting based on market capitalization. In this type, the division of each stock in a basket is based on the market value of the shares.
We also have revenue weighted indexes and float-adjusted index.
Also read: Spot Stock Trends before other Traders!
The Advantages
BY index you will have a better way to get exposed to certain markets or sectors without cornering the market in stocks. By index, you also have easier access to buy a commodity, instead of buying some cattle, barrels of oil, and a few bags of rice.
The Disadvantages
Even an index can emulate a certain market, yet, that is not 100% accurate. When you buy a foreign market index in a certain region that does not make your basket to move exactly with the economy of that region.
There are many factors can alter the course of a market that sometimes an index can’t reflect, at least not immediately.