What is a stock market index? How indices are built and weighted

A stock market index is a statistical yardstick for a group of shares. Instead of tracking hundreds of prices, investors follow one number: when people say 'the market rose 1% today', they usually mean an index such as the S&P 500, the Dow Jones, the DAX or the BIST 100.

Indices serve three purposes: they summarise how a market or sector is doing, they act as benchmarks for judging fund managers, and they are the blueprint that index funds and ETFs copy. You cannot buy an index directly — only products that track it.

The index level is the combined value of its members divided by a divisor, which the provider adjusts so that stock splits, capital changes or membership changes don't make the index jump:

Cap-weighted:   Index = Σ(price × shares × free-float factor) ÷ divisor
Price-weighted: Index = Σ(prices) ÷ divisor
Weight of a stock (cap-weighted) = its market cap ÷ total market cap

In a market-cap-weighted index such as the S&P 500, the biggest companies carry the most weight; free-float adjustment counts only the shares actually available to trade. A price-weighted index such as the Dow Jones Industrial Average gives more influence to stocks with higher share prices, regardless of company size.

Take a price-weighted index of three stocks priced at 10, 20 and 90, with a divisor of 3: the index is (10 + 20 + 90) ÷ 3 = 40. If the 90 stock rises 10% to 99, the index moves to 129 ÷ 3 = 43, up 7.5%. If instead the 10 stock rises 10% to 11, the index edges up to 121 ÷ 3 ≈ 40.33, just 0.8%. The same percentage move can matter very differently depending on the weighting.

Because index levels are arbitrary — they depend on a base value set long ago — comparing levels across indices is meaningless. A move from 10,000 to 10,500 and one from 1,000 to 1,050 are both +5%.

Cap-weighted indices can become concentrated: when a handful of giant companies dominate, the index behaves less like a diversified basket than its name suggests. Members also change over time — weak companies drop out, strong ones join — so an index's long-run record looks better than the fate of its original members.

Check whether an index is a price index or a total-return index. The S&P 500 and the Dow are usually quoted as price indices that exclude dividends, while Germany's DAX is a performance index that assumes dividends are reinvested — which makes long-term comparisons between them misleading.