What is a stock index? How the S&P 500, Dow, DAX and others are built

A stock index is a single number that tracks the combined value of a defined group of shares, calculated according to published rules. The rules decide which companies are included, how much weight each one carries, and how the number is adjusted for dividends, splits and changes in membership. When people say "the market was up 1% today", they almost always mean an index such as the S&P 500, the FTSE 100 or the DAX.

The number itself is not something you can own. It is a measurement, like a temperature. But because so much money tracks or trades indices through funds, futures and CFDs, understanding how an index is built tells you a lot about how it will behave, and why two indices that both describe "the market" can move quite differently on the same day.

What an index is for

Indices serve three broad purposes:

• A barometer. They summarise the direction of a market or a sector in one figure. Newspapers, central banks and economists quote them for that reason.
• A benchmark. Fund managers are judged against an index. A fund that rose 8% when its benchmark rose 12% has underperformed, even though it made money.
• An underlying for products. Index funds and ETFs aim to replicate an index; futures, options and CFDs are priced from one. Our guide to ETFs explains how funds track an index, and trading index CFDs covers the leveraged route.

Because of that third role, index methodology is a commercial product. The S&P 500 is owned by S&P Dow Jones Indices, the FTSE 100 by FTSE Russell, the DAX by STOXX (part of Deutsche Börse), the Nasdaq 100 by Nasdaq and the Nikkei 225 by Nikkei Inc. Each publishes its rulebook.

How the number is built

Every index answers the same three questions: which shares, how much of each, and how to keep the series continuous when things change.

Choosing the members

Membership rules range from purely mechanical to partly judgement-based.

• The FTSE 100 is close to mechanical: broadly, the largest eligible companies listed on the London Stock Exchange's main market, ranked by market capitalisation and reviewed every quarter, with buffer rules so that companies near the cut-off do not churn in and out.
• The Nasdaq 100 takes the largest non-financial companies listed on the Nasdaq exchange, selected once a year in December, with weights rebalanced quarterly.
• The S&P 500 is chosen by a committee at S&P Dow Jones Indices using published criteria, including size, liquidity, free float and a record of positive earnings. Meeting the criteria does not guarantee inclusion; the committee also considers sector balance.
• The Dow Jones Industrial Average has just 30 members, chosen by a committee to represent leading US companies, with no fixed size rule.

Weighting: market capitalisation

Most major indices are market-capitalisation weighted: each company counts in proportion to its total market value (share price × number of shares). A company worth 3 trillion dollars carries 30 times the weight of one worth 100 billion.

Almost all now use free-float market cap: they count only the shares available to ordinary investors, excluding blocks held by governments, founders, parent companies or other strategic holders. A company with a large founding-family stake therefore counts for less than its headline market value suggests.

Cap weighting has a useful property: if you hold each share in proportion to its market value, you do not need to trade when prices move, because the weights drift exactly as the index does. That makes it cheap to track. Its downside is concentration. When a handful of very large companies dominate, the index becomes a bet on them. Several index providers therefore apply caps, limiting any single constituent's weight. The DAX caps each company at 10%, and the Nasdaq 100 has its own concentration rules applied at quarterly rebalances.

Weighting: price

A price-weighted index simply adds up the share prices of its members and divides by a number called the divisor. A share priced at 400 counts four times as much as one priced at 100, regardless of the size of the companies.

The Dow Jones Industrial Average and the Nikkei 225 are the two famous price-weighted indices. Price weighting is a historical artefact from the days when indices were calculated by hand, and it produces odd results: a company's influence changes when it splits its shares, even though its value does not.

Worked example: a price-weighted index and its divisor

Illustrative numbers only. Imagine a three-stock price-weighted index:

• Share A: 300
• Share B: 150
• Share C: 50
• Sum: 500. With a divisor of 5, the index stands at 100.

Now share A does a 2-for-1 split, so its price drops to 150. If nothing were adjusted, the sum would fall to 350 and the index to 70, a 30% "fall" caused by nothing at all. To prevent that, the index provider changes the divisor so the index value is unchanged:

• New sum: 150 + 150 + 50 = 350.
• New divisor: 350 ÷ 100 = 3.5. Index: 350 ÷ 3.5 = 100.

Continuity is preserved, but notice what changed: before the split, a 1% move in share A moved the index by 3 ÷ 5 = 0.6 points; afterwards it moves it by 1.5 ÷ 3.5 ≈ 0.43 points. The split reduced A's influence on the index without any change in A's economic size. That is the core weakness of price weighting.

Worked example: a cap-weighted index

Illustrative numbers only. Three companies with free-float market values of 600, 300 and 100 (in billions):

• Total: 1,000. Weights: 60%, 30%, 10%.
• If the largest company rises 5% and the others are flat, the index rises 0.60 × 5% = 3%.
• If the smallest company rises 5% and the others are flat, the index rises 0.10 × 5% = 0.5%.

That is why the biggest companies drive cap-weighted indices. On days when a few very large technology shares move sharply, the S&P 500 and especially the Nasdaq 100 can move a lot even if most of their members are flat.

Equal weighting and other approaches

Some indices give every member the same weight and reset that weight at each rebalance. Equal-weight versions of the S&P 500 exist, for example. They reduce concentration but require regular trading to maintain, which costs money for funds that track them. Others weight by fundamentals such as revenue or dividends. For trading purposes, though, the headline indices quoted by CFD providers are almost always the standard cap-weighted or price-weighted versions.

Price, total return and net return indices

When a company pays a dividend, its share price falls by roughly the dividend on the ex-dividend date (see dividends and corporate actions). An index has to decide what to do with that drop.

• A price index lets it show. Dividends leave the index, so over long periods a price index understates what an investor who reinvested dividends would have earned.
• A total return index (also called a gross return or performance index) assumes every dividend is reinvested in the index, so ex-dividend drops do not pull it down.
• A net return index does the same, but after deducting a standard withholding-tax rate.

Most headline indices are quoted as price indices: the S&P 500, Dow, Nasdaq 100, FTSE 100 and Nikkei 225 numbers you see on the news are the price versions. The well-known exception is Germany's DAX, whose headline figure is the performance (total return) index. A price version of the DAX exists, but the one quoted on screens and used for most products is the performance index. This matters for comparisons: over long periods the DAX headline figure includes dividends while the FTSE 100 headline figure does not, so comparing the two charts directly flatters the DAX. It also matters for CFDs, because a cash DAX CFD normally has no dividend adjustments, whereas CFDs on price indices do.

The major indices at a glance

S&P 500

The S&P 500 covers large US companies selected by committee and is weighted by free-float market capitalisation. It is the most widely used benchmark for US equities and the underlying for a huge range of funds and derivatives. It has slightly more than 500 lines because a few companies have more than one class of share in the index. Weights are rebalanced quarterly, and membership changes are announced whenever the committee decides, often because a company has been acquired or has shrunk.

Dow Jones Industrial Average

The Dow tracks 30 large US companies and is price-weighted, using a divisor that has been adjusted many times over its history for splits and membership changes. Because it is price-weighted and small, it can behave differently from the S&P 500 on a given day: a large move in a high-priced share has an outsized effect. It remains widely quoted, mostly for its history and familiarity.

Nasdaq 100

The Nasdaq 100 holds the 100 largest non-financial companies listed on the Nasdaq exchange, weighted by a modified market-cap method that limits concentration. It is dominated by technology and communication companies, which is why it is often used as a shorthand for "US tech". Membership is reconstituted annually in December, with quarterly rebalances of weights. Do not confuse it with the Nasdaq Composite, a much broader index of nearly all shares listed on Nasdaq.

DAX

The DAX tracks 40 large companies listed in Frankfurt; it was expanded from 30 members to 40 on 20 September 2021. It is weighted by free-float market capitalisation with a 10% cap per company, and the headline figure is a total return index. Many DAX companies are export-oriented industrials, carmakers, chemicals and financial firms, so it is sensitive to global trade and the euro.

FTSE 100

The FTSE 100 contains the largest companies on the London Stock Exchange main market, weighted by free-float market capitalisation and reviewed quarterly. A large share of its members' revenues comes from outside the UK, which is why the index often behaves differently from the UK economy and can rise when sterling falls, as overseas earnings are worth more in pounds. It has heavy weights in energy, mining, banking, pharmaceuticals and consumer staples, and relatively little technology.

Nikkei 225

The Nikkei 225 tracks 225 Japanese companies listed on the Tokyo Stock Exchange Prime market and is price-weighted, with each share's price multiplied by a price adjustment factor before summing. Because a few high-priced shares can dominate a price-weighted index, Nikkei introduced a weight cap: if a stock's weight exceeds 10% at a periodic review, its adjustment factor is scaled down by a capping ratio. Membership is reviewed twice a year, in April and October. The cap-weighted TOPIX is the broader alternative benchmark for Japan.

Other indices traders see

CFD providers commonly also quote the Euro Stoxx 50 (large companies across the euro area), France's CAC 40, Australia's ASX 200, Hong Kong's Hang Seng and a US small-cap index such as the Russell 2000. Each has its own rulebook, trading hours and character. Under ESMA rules, CFDs on a defined list of major indices, which includes the FTSE 100, DAX, CAC 40, Euro Stoxx 50, Dow, S&P 500, Nasdaq 100, Nasdaq Composite, Nikkei 225 and ASX 200, can be offered to EU retail clients at up to 20:1 leverage, while other indices are limited to 10:1. See CFDs on stocks, indices and commodities for how leverage varies by asset.

Rebalancing and reconstitution

Indices are not static. Two kinds of change happen on a schedule:

• Reconstitution: members are added or removed according to the rules. A company that grows into the top 100 enters the FTSE 100; one that shrinks drops out.
• Rebalancing: weights are recalculated, share counts and free-float factors are updated, and caps are reapplied.

Changes are announced in advance and usually take effect after the close on a set day. Funds that track the index must trade on that day to match the new composition, which can produce heavy volume in the closing auction of the affected shares. Some traders try to anticipate index changes, but by the time a change is announced it is widely known. For the purposes of most traders, the practical point is that unusual volume and volatility in individual shares around review dates is normal.

Unscheduled changes also happen. When a member is acquired or delisted, it is replaced, often at short notice.

What moves an index

An index moves because its members move, and its biggest members matter most. Beyond that, the drivers are the ones that move shares in general:

• Earnings and guidance from the largest constituents, especially during reporting seasons.
• Interest rates and bond yields. Higher yields raise the rate used to discount future profits and offer a competing return. Our guides to central banks and interest rates and bonds and yields explain the link.
• Economic data, such as employment, inflation and business surveys, mainly through what it implies for rates and profits.
• Currency moves, particularly for indices with large overseas earnings like the FTSE 100.
• Risk sentiment, which tends to move all equity indices in the same direction during broad sell-offs, although the size of the moves differs.

Sector mix explains much of the difference between indices. A day when oil and mining shares fall and technology shares rise can see the FTSE 100 down while the Nasdaq 100 is up.

Common mistakes

• Treating the Dow as "the US market". It has 30 members and is price-weighted. The S&P 500 is a much broader measure.
• Comparing a total return index with a price index. Long-run DAX and FTSE 100 charts are not like for like.
• Assuming diversification. A cap-weighted index can be highly concentrated in a few companies or one sector. Check the top weightings before treating it as broad exposure.
• Confusing the index with the product. A CFD or ETF on the S&P 500 follows the index but has its own price, costs, hours and adjustments.
• Ignoring the session. Each index's underlying shares trade on one exchange with set hours; the stock exchange hours tool shows which are open now. CFD prices outside those hours are usually derived from futures and can be wider.

Frequently asked questions

Can I buy a stock index directly?

No. An index is a calculated number. To get exposure you use a product based on it: an index fund or ETF, a futures contract, an option, or a CFD. Each has different costs, risks and tax treatment, and leveraged products such as CFDs and futures can lose more than you expect very quickly.

Why is the DAX called a total return index?

Because its headline figure assumes that all dividends paid by its members are reinvested in the index. When a DAX company goes ex-dividend, the index is not pulled down by the payout. Most other headline indices, including the S&P 500 and FTSE 100, are price indices that do fall when members go ex-dividend.

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

In a price-weighted index, such as the Dow or the Nikkei 225, higher-priced shares count for more regardless of company size. In a market-cap-weighted index, such as the S&P 500 or FTSE 100, larger companies by market value count for more. Cap weighting reflects economic size; price weighting reflects share price, which changes with splits.

How often do indices change their members?

It depends on the index. The FTSE 100 is reviewed quarterly, the Nasdaq 100 is reconstituted annually in December, and the Nikkei 225 is reviewed in April and October. The S&P 500 and Dow are managed by committees and change whenever the committee decides, often when a member is taken over.

Why does the FTSE 100 sometimes rise when the pound falls?

Many FTSE 100 companies earn most of their revenues abroad. When sterling falls, those overseas earnings are worth more in pounds, which can support the share prices. The relationship is not fixed, and other factors often dominate.