The "secret" behind the financial stock index

Understanding about Stock Index

When we talk about financial market, the most common topics among discussion would be What is the stock index today? Has the stock index broken new record high? What cause the stock index move up or down? and most of the people may express the frustration that although the stock index hit record high, but they did not feel the benefit at all. In order to answer those questions, it would be important to dwell deeper for a better understanding about stock index.

Definition of Stock Index

A group of stocks put together in a standardized way to provide a useful window into a sector or market's performance at a glance. That is, a stock index groups together a certain list of stocks and usually takes an average of their prices so as to provide an idea of how the industry or market represented in the stock index is doing. Very often, stock indices are weighted to prevent a few data points from overwhelming it. For example, the S&P 500 is weighted according to market capitalization, while the DJIA is weighted for price.
(Source: Farlex Financial Dictionary. © 2009 Farlex, Inc. All Rights Reserved)

Interpretation of Stock Index movement

For me, ideally, the stock index is a very important guideline as it shows the condition of the economy and it is formed with the purpose as an economy indicator. Tehnically, stock index should move about 3-6months ahead aligned with the economy direction. However, you may detect a lot of misleading indicators especially when the stock index move against the economy direction. This creates the confusion and misinterpretation to the investors, subsequently misleading the investors with the wrong investment desicion.

Manipulation of Stock Index

As you know, stock index consists of a group of blue chips counters / components such as DJ index (30 components), Malaysia stock index (30 components), Germany Dax (30 components), etc... These components are definitely good strong fundamental organizations which have been selected to represent a country's economy condition. However, there are many occasions you may notice easily that the index may keep continue moving higher and higher in a long run when the component stocks grow bigger and bigger. Practically, the index component stocks valuation needed to be examed from time to time, the loser may be kicked out from the index components (Ex: Citigroup), the next winner will be selected to replace the seat. Thus, this will definitely stabilise the stock index and subsequently solidify investors confidence. For me, this may be one of the effective way of maniputaing the stock index legally. So, the question for you is: How much do you willing to trust the stock index / the government?

Good investment return in stock index counters

Generally, in a longer run and for the convenience purpose, it should be safe to select index stocks as long term investment choice as it bring the high Return of Investment (ROI) in a attractive compounding rate. Most of the index stocks provide good return, high dividends, and stability to the investors. This may partly due to they are about "Too big to fail"! No matter what, the government will try to save and support the index counters. Thus, for the newbies and some professional investors, stock index counters are definitely one of the good choice for them.