How the stock market works

1  2  3  4  5  6  7  8  9  10  11  12  13  14  15  16  17  18   

7. Reasons for market indices

Share prices go up and down, and obviously you want your shares to go up rather than down. But if they do go up, does it mean you're a talented stockpicker, and if they go down does it mean you're a lost cause?

Not necessarily. You have to judge your performance relative to the performance of other shares.

• If the market as a whole has gone up further than a share you own, your selection is arguably a failure even if you have made money, because you could have done better.
• If the market as a whole has gone down further than a share you own, your selection is arguably a success even if you lost money, because you could have done worse.

Indices are simply ways for you to compare your performance against the rest of the market, and they work by picking a collection of shares, giving them weightings, and producing an average performance indicator for the index.

Unit trusts, investment trusts, and pensions funds judge their performance in exactly the same way: by working out whether they have, overall, 'beaten the index'. The index which they are trying to beat will depend on whether they have any particular specialisation.

The other important role of indices is that they form the basis of 'passive investment' - the term which describes the way 'tracker' funds invest. Briefly, these funds use computer models to choose a portfolio which matches a particular index, on the premise that the performance of the fund will then be exactly the same as the performance of the index.

1. Why do companies list on the Stock Exchange? 2. Offers for sale 3. Offers by tender, and other methods of admission 4. The Official List 5. AIM and OFEX 6. Different types of share 7. Reasons for market indices 8. The FTSE indices 9. Sectors 10. Scrip issues 11. Rights issues 12. Convertibles 13. Warrants 14. Share buybacks 15. Shareholder perks 16. Suspension 17. Insolvency 18. Conclusion