Understanding Indices

A stock market index is a single number calculated from the prices of many different stocks. Index is also called indices when you talk about more than one of them. Indices are used as benchmarks of stock performance for portfolios like mutual funds.

Some investment funds (index funds) manage their portfolio so that their performance mirrors (tracking) the performance of a stock market index or a sector of the stock market.

For example, when you hear that the Consumer Price Index (CPI) for say, January to December 2005 increased by 3.0% to 109.1 compared with that of 105.9 in the same period last year. This tells you that the change in retail prices paid by households for goods and services increased in that period. CPI is designed to provide a broad measure of changes in retail prices.

An index is a tool which enables investors to measure the performance of a group of stocks from a defined market. It can form a benchmark for active or passively managed portfolios covering the particular market. Being part of an index is also a status symbol for the constituent companies and trading of constituent shares obviously supports the share price. Indices also allow the creation of investment products that give investors exposure to markets or groups of stocks which can help in markets where there are barriers to investment.

Stock market indices may be classed in many ways. A broad-base index represents the performance of a whole stock market— and reflects how investors feel about the economy. The most regularly quoted market indices are broad-base indices comprised of the stocks of large companies listed on a nation's largest stock exchanges, such as the American Dow Jones Industrial Average and S&P 500 Index, the British FTSE 100, the French CAC 40, the German DAX and the Japanese Nikkei 225.

The Use of Indices

Stock indices have developed in the last twenty years to become much more than economic indicators (market barometer) and with growing developments in financial markets, more technical functions of indices have been brought to the forefront.

Stock indices are used by investors and fund managers as one of the many tools to evaluate the performance of a stock market The application of indices is now much wider including the use of indices as benchmarks for investor portfolio comparisons and as underlying components of financial products, for example Exchange Traded Funds (ETFs) and derivatives.

Bursa Malaysia Indices

The existing Bursa Malaysia indices are calculated using the market capitalisation weighted method.

Market capitalisation means the total value of a listed companies shares based on the current market price. Therefore the bigger companies are given higher weightage compared to the smaller companies.