We will now look at a group of equities known as an index to create an index. We take individual prices multiply them by awaiting methodology and create an index level. There are of course a number of complexities and how indexes are calculated how adjustments for Dividends are made how reweightings are done and what other adjustments are made rights issues special dividends Etc, but we will keep it simple and only discuss the basic waiting methods equal weight price weight and market cap weight important to highlight here that the waiting method you choose will heavily impact your returns. In fact, the waiting methodology is your asset management decision. This is the reason fundamentally weighted indexes, which we will discuss in a moment have grown in popularity. Index is represent a given security Market segment or asset class. In the US, we have the Dow Jones International the S&P 500 the NASDAQ Composite and the Russell 2000 as examples internationally. We have the footsie which is based in the UK the Dax based in Germany the Hong saying in Hong Kong and the Nikkei in Japan an example of a global index would be the msci the Morgan Stanley Capital International. Other indices are sector or industry specific style specific total return specific or multi-market sector Industries represent and track different economic sectors such as consumer goods energy Finance Health Care technology on either a national Regional or Global basis. Sector indices are organized as families each index within the family represents an economic sector. Typically, the aggregation of a sector index family is equivalent to a broad market index multi-market Equity indices, usually compromise indices from different countries and are designed to represent multiple security markets.

Market value weighted indices are also known as market cap weighted or cap weighted in the market capitalization waiting the weight on each constituent security is determined by dividing its market capitalization by the total market capitalization of all the Securities in the Index market capitalization or value is calculated by multiplying the number of shares outstanding by the market price per share. So in the end the largest companies by value have the biggest influence on the value and the overall change in the index. The advantage of a capuated index is obvious. It reflects. The way markets actually behave larger companies do in fact have more dramatic effects on the overall market and economy then smaller companies. So it is beneficial to give them a larger weight. It's also a self-rebalancing methodology in that as a company's price changes. So two do the proportions of stocks in the index basket. The primary disadvantage is that the underlying security whose prices have risen the most or Fallen the most have a greater or lower weight in the index this weighting method leads to overweighting stocks that have risen in price and may be overvalued and underweighting stocks that have declined in price and maybe undervalued the effect of this weighting method is similar to a momentum investment strategy, which essentially bets that near-term price movement will continue alternative waiting schemes to cap waiting such as reverse waiting have gained more favor in recent years.

A price weighted index like the Dow Jones is simple to calculate simple to understand and simple to create however regardless of the issuing companies actual size or the number of shares outstanding. If one of the higher price stocks has a huge pricing increase the index is more likely to increase even if the other stocks in the index decline in value at the same time also stock splits result in arbitrary changes in weights.

In an equal weighted index small companies or companies with low prices have the same impact as larger ones fund managers must constantly rebalance their portfolios due to daily price fluctuations basket turnover is much higher than in a cap weighted index meaning that any funds tracking it will often be more expensive than comparable cap weighted ones.

Fundamentally weighted index strategies screen Securities in a fashion similar to that of many actively managed mutual funds but by following a rules-based discipline based only on the predefined metrics. The most important property of fundamental weighting is that it leads to indices that have a value tilt that is a fundamentally weighted index has ratios of Book value earnings dividends Etc to a market value that are higher than it's market capitalization weighted counterpart also in contrast to the momentum effect of market capitalization weighted indices fundamentally weighted indices generally will have a contrarian effect and that the portfolio awaits will shift away from Securities that have increased in a relative value in towards Securities that have fallen in relative value whenever the portfolio is rebalanced to achieve this however requires a great deal of data.