What is a stock market index?
When you invest in a company, you essentially buy a piece of the company in the form of stock, bonds and/or other securities.
In order for you to make informed decisions, it is therefore important to understand how the prices are determined and whether these prices are good.
One way to do this is to use a Stock Market Index.
How are prices of stock determined?
In the same way that food is bought and sold at a food market, stocks and other securities are bought and sold at the stock market.
However, unlike a food market, where the prices are clearly marked, the prices at a stock market are determined more like an auction. Meaning, buyers name the highest price they are willing to pay, and sellers name the lowest they are willing to accept. The final price falls somewhere in between.
This negotiation happens via electronic trading platforms or by employing professional stockbrokers who act on behalf of clients to manage their portfolio.
How do you know the prices of stock?
A common way for investors to assess the proposed price for shares is to use a stock market index.
Simply put, this is a measurement tool that broadly tracks the performance and trends of groups, such as industries or sectors. These indexes provide a general idea of ‘how the market is doing’ which investors can follow instead of actively making every individual decision.
Some of the most popular global stock market indexes included: MSCI World Index, FTSE All-World Index and S&P Global 100 Index.
How does it work?
One way to go about using a stock market index to inform your investment decisions is to invest in an index-tracking instrument. One example of this is an Exchange Traded Fund (EFT).
For example…
Say you are passionate about addressing climate change and decide to invest only in companies that are working on promoting clean energy. You could actively research the industry, pick a couple of companies that you meet your criteria and buy stock in these companies directly.
Another way would be to choose an ETF that focuses on clean energy. By investing in the ETF, your portfolio is broad and perhaps includes companies engaged in a mix of wind power, solar power and other renewable sources.
And since the ETF will automatically follow the stock market index of the industry, your financial strategy can be more passive.
The decision of what to invest in and how to do it always comes back to meeting your needs and interests. For this reason, it’s important to do some background research before deciding how to invest your money.
Kate Harris is a copywriter at MakeImpact, a Nordic Impact Fintech that helps individuals make sustainable investment decisions through their values.
