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A stock index can give you a good idea of how the overall stock market, or a certain portion of the stock market is performing. The Dow Jones Industrial Average is perhaps the best-known index, but isn't widely considered to be a great snapshot of the entire market, as it consists of only 30 companies.
Other popular market indices include the S&P 500, which is generally considered to be a great indicator of how the overall market is performing, the tech-heavy NASDAQ Composite index, and the Russell 2000 index, a broad index of small cap companies. There are also indices for individual sectors, such as technology, healthcare, and finance, which can help track the performance of certain types of companies.
Indices can also be useful for measuring the performance of your own portfolio against a benchmark. For example, if your stock portfolio drops by 7% in a certain month, but the S&P 500 drops by 10%, you are still beating the market even though the value of your holdings fell.
Calculating the return of stock indices
To calculate the return of a stock index between any two points in time, follow these steps:
First, find the price level of the chosen index on the first and last trading days of the period you're evaluating. Be sure to use the opening price on the first day and the closing price on the last in order to make sure your calculation is as accurate as possible.
Next, subtract the starting price from the ending price to determine the index's change during the time period.
Finally, divide the index's change by the starting price, and multiply by 100 to express the index's return as a percentage.
Putting the formula together, we have:
Note: This formula is useful for determining the return of individual investments as well.
An example
Let's say that you want to calculate the return of the S&P 500 index during the month of October 2015.
First, using an accurate price chart, determine the starting and ending price. In this case, on October 1, the S&P 500 opened at 1,919.65 and on October 30, the index closed at 2,079.36.
Using the formula mentioned above, we can see that:
A positive percentage indicates that the index increased during the time period, while a negative percentage indicates that the index fell. So, during October 2015, the S&P 500 increased in value by 8.3%.
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