A stock index is a way to measure the performance of the group of data on multiple stocks that reflects the value of the constituent stocks on the market. It is often used to show the common characteristics of the constituent stocks, such as stocks that are traded on the same stock exchange, belonging to the same industry, or have similar market capitalization.

There are mainly three types of stock index by the method of calculation.

Price-weighted index, grants each company a different weight based on its current share price. Companies with larger share prices have more influence in these indexes, regardless of how big or small the companies actually are. Examples include, Dow Jones Industrial Index(DJIA) and Nikkei 225 (JPN225).

Market-value weighted index, also sometimes referred to as market-cap weighted or capitalization-weighted index. The index more heavily represents stocks with higher market caps. With this structure, large companies have a bigger impact on the index’s performance. The Standard & Poor 500 (S&P500), and the Hang Seng Index (HSI) are examples of the market-cap weighted index.

Market-shared weighted index also called Unweighted or equal-weighted index, which is calculated based on the weighted average number of shares instead of market capitalization. All stocks, regardless of share volumes or price, have an equal impact on the index price. The price change in the index is based on the percentage return of each component.

Essentially you will be trading on what is called a “basket of stocks” or a combination of stocks. The great thing is that you don’t have to own the stocks to be able to trade them. Some indices follow a certain category of stock – for example the Nasdaq is composed of non-financial companies – Apple, Amazon, Alphabet Class A (Google), Intel and more.

Index trading is defined as the buying and selling of a specific stock market index. The trader speculates on the price of an index either to be rising or falling which then determines their action of buying or selling.