The quotation indices are the most representative elements for the analysis of the stock market, being they the most agile and simple instruments to reflect the evolution and trend of stock prices
An index can be defined as a statistical instrument that represents in an abbreviated and simple way, in a single average number, multiple variations of a given phenomenon with homogeneous characteristics during a determined period.
In the specific case of the stock market, a Stock Price Index is an average indicator that reflects, in a number, the aggregate variations in the prices of a group of shares.
Briefcase
There is no unified criterion for the conformation of the index portfolio, these are considered for each of the companies against their characteristics in terms of the stock market
The potential users of a Stock Price Index are very diverse. As the index is an abbreviated representation of market variations, it is a mandatory reference for stock brokers, financial and economic analysts and the investing public.
These different users, with different concerns, expectations and needs, find different possibilities of using the index since in general it:
1. It is a synthetic information mechanism of the percentage fluctuations in stock prices.
2. It is a true reflection of what is happening in the market by allowing the evolution, trend and cycles presented in the stock market to be identified.
3. Provides bases and criteria for comparison in investment decisions in general and in the selection of stock portfolios in particular.
4. It makes it possible to relate the existence of short-term economic situations with the variations in the stock market and to infer conclusions about the existence or not of certain factors causing the evolution of share prices.
5. It is an important auxiliary indicator in the analysis of stock prices in current and constant terms.
6. Serves to obtain guidelines on the conditions in which the market is developing.
The index and changes in share prices
When analyzing variations in the level of share prices, it should be borne in mind that there are fluctuations in prices caused by:
- Influences conditioned by the market: These are those produced by the exclusive action of market supply and demand. Influences outside the market: These are fluctuations in prices not conditioned by the market. Thus, the level of share prices may undergo changes caused by decisions outside the market. Such is the case of changes in the price level due to new issues, payment of dividends in shares, reduction or increase in the nominal value of shares, among other events.
If you want the index to measure only the variations in stock prices regardless of the cause that motivates them, that is, without taking into account whether they occur due to external or non-market influences, we speak of using an Index without Debugging.
In the Stock Exchanges, the fluctuations in the prices of the papers that are negotiated, are guidelines to infer statistically the conditions in which the fluctuations of the market develop
On the contrary, if you want to measure the variations motivated only by the influences conditioned by the market, you talk about using a Debugged Index; This is obtained by incorporating technical corrections or rectifications to the basic formulas, to isolate the factors causing such a situation.
Shares represented in the index calculation
A fundamental aspect that must be considered in the structuring of the index is the stock comparison; in other words, on what number and group of actions its calculation is made.
The most used trends for its calculation are:
- Total Portfolio: Includes all shares listed on the stock exchange. Partial Portfolio: A specific sample of stocks on the stock market is included.
In index theory, the aspect of the share composition of the index is referred to as the selection of a Typical Portfolio or a Hypothetical Portfolio. The first is supposed to be made up of the portfolio of shares of an average investor, the second is generalized under the inclusion of all shares in the market.
Under this simple but broad generalization, it should be taken into account that there are a large number of stocks that present a minimum level of transactions for which it is very difficult to set a representative stock price.
These facts are reflected through Stock Market Liquidity indicators that relate the number of shares traded in the year and the number of shares in circulation of the company as of January 1 of each year and the trading frequency that relates the number of wheels in which one share was traded against the total number of stock market rounds for the period.
Finally, it should be taken into account that regardless of whether an index is calculated based on all the shares on the market, a large number of Stock Exchanges in turn calculate a Stock Price Sub-Index based on the most representative portfolio of the shares that they are traded on that market.
In this way, the investor has an index that serves as more of a reference in the adoption of a practical investment policy, as it reflects the reality of the stock market in terms of the actions that actually have an active negotiation.
Indices are average indicators of the general behavior of the stock market, which is why business investment decisions must be made on them
Weighting of shares
Weighing the importance of a share within a portfolio is simply obtaining a coefficient that relates the relevance of such a share within the shares that make up said portfolio. There are marked differences of opinion on whether or not it is appropriate to calculate the indices with or without weighting. The most common classification leads the application of one or another calculation system is to divide the indices into:
Simple or unweighted index
Under this calculation system, the shares that intervene in the index have an identical participation in global fluctuations, the unweighted index being a simple arithmetic average of price variation.
For this reason, the average variable is considered in each particular action in the same way. In this way, the most dynamic stocks on the market are tacitly made comparable with those at any level of activity.
Weighing
A weighted index is used to reflect variations in the prices of shares with a high level of heterogeneity
Weighted index
In this form of calculation, the most active and representative companies on the stock market, in traded volume or in stock market capital, are assigned a greater relative importance within the market.
When considering this, it is convenient to specify that the stock market is not always in reality composed of shares of a homogeneous level, but rather innumerable different behaviors, which is reflected in the great heterogeneity existing in the price of the different shares.
At present, the Indices are calculated bearing in mind some form of weighting. These can be diverse, being the most used:
- Share capital or Market capitalization Volume traded Time average of transactions Activity level and price
Market capitalization
Market capitalization is taken as a reference, since it presents the value of companies at market prices. Due to the diversity in the value of this capitalization per company, it could be that only a few shares represent a very high percentage of the total market capital considered, exerting a very strong influence on the performance of the index, without necessarily being the most representative shares. and market dynamics.
Volume traded
When evaluating all aspects related to the weighting of the indices according to the Volume Traded, it should be taken into account that the individual price changes of the different stocks are made on very different trading volumes.
Time average of transactions
Variations in prices are the result of stock trading that normally affect a limited part of the total shares of a company, so there must be some form of weighting that weighs the real stock market activity, that's where the calculation comes in. of the temporal average of transactions.
Activity level and price
This results from the shares that are traded and not from the total volume of the shares that remain outside the market.
The Market Capitalization is calculated as the product of the shares in circulation times the price of the company's share on the stock market.
Regardless of the form of weighting used in calculating the index, there will be a greater concentration of certain stocks, hence the importance of choosing a large and representative sample of stocks that are highly important in the stock market, so that at weighing the active market is being faithfully represented.
Construction of the indices
In the construction of indices that measure and represent in a real way the behavior of a phenomenon, in this case the stock market, there are aspects of great relevance such as: composition, corrections, weighting, periodicity, base, etc.
Mathematical reason
The practical reasons related to the choice of the mathematical formula are highly subjective. There is no consensus on a better formulation of the index and as such, there is a great diversity in the formulas used, without for this aspect, it can be said that one index is better than another.
Depending on the formula chosen, the indices can be classified as " fictitious indices " and " real indices ".
Fictitious indices
These are normally arithmetic or geometric averages, they are simple or unweighted indices. Its calculation is practical and its handling simple, but its results are not considered obtained on the same elements and magnitudes, since they are calculated on the isolated variations of prices regardless of the volume of negotiations carried out.
Real indices
These are considered better indices in statistical theory, within which the following stand out:
- Laspeyres Price Index Paasche Price Index Fisher Index Stock Index
A choice between these indices may be more related to the objective that one wants to give the index, than to the choice of them for mathematical reasons.
Subdivisions
The diversity of the shares that make up the market makes their heterogeneity less indicative of the index, as a mechanism to observe the specific behavior of a certain group of shares. Thus, when an indicator is required for more homogeneous stocks, we speak of subdivisions in the index, in the form of previously determined groups and subgroups.
There are various grouping possibilities that respond to subjective criteria or particular wishes of users, thus, the most commonly used subdivision is " Specific Sectors of Activity ". The tendency is to seek greater specialization in the structuring, presentation and use of the indices, although when there are very limited subdivisions, it may be possible to present that the index of a subgroup is practically that of a share.
Once the general structuring of the index has been defined, the construction of a series or set of indices can be done in a sequential or dependent manner, that is, relating the global index, the different subdivisions and the base index of each share.
Index base
One of the simplest, but fundamental aspects in the construction of the index is the choice of the initial reference date, or in more technical terms, the base of the index.
Its importance lies in the fact that against this base the evolution of price variations is determined, although in the medium and long term the periodic alterations of the index will be the main information, regardless of what was the initial basis for comparing the prices. quotes.
In general, one can speak in the theory of " Fixed base indices " in which the initial reference base remains unchanged and the " Chain indices " in which the base is variable and refers to the previous calculation day, but the base date remains in the background unchanged, but it is no longer the required calculation reference.
With reference to the base there are two alternatives, a date or a specific day and a base period. A base date is normally referred to a day highlighted by some particular fact, to a pre-existing date compared to other indices, or normally to the last round of a year.
Regarding the choice of a stable base period, be it a weekly, monthly, quarterly or annual average, the criterion is to have a reference average freer from extraordinary influences in order to avoid possible deformations due to particular circumstances of a stock market wheel.
