Indices and Exchanges: The Overview
Indices VS. Exchanges
By this point, you may have seen the terms “index” and “exchange” quite a bit, but what are they exactly? Here’s a quick look at the major differences between the two.
An Index acts as a statistical measure of change in the market. In terms of the financial market, an index is an imaginary portfolio of different stocks, designed to represent a particular market or a part of it. Each index has a different methodology for ranking stocks based on one or more selection criteria. Indexes are usually expressed as percentage changes from a base value.
Sidenote: the percentage change is more meaningful than the actual dollar price change, since it represents the degree of the increase or decrease. Take for example: Stock A moves from $5 per share to $10 per share. Stock B moves from $20 per share to $25 per share. Both move up $5 per share. Yet, for Stock A this means a 100% increase while Stock B is 25% up. Most traders prefer logarithmic charts reflecting the percentage change in prices rather than mathematical charts showing the actual dollar amount of change because dollar price changes don’t reflect the magnitude of change.
The best-known indices are The Standard and Poor’s 500 and the Dow Jones Industrial Average. These two are often used as benchmarks for the stock market because they include a wide range of companies that best represent movements in the overall market. There’s also a wide variety of other indices that you can use to track the performance of different sectors or country-specific stocks. It all depends on your investing style or objectives.
That said, you can’t actually invest in an index. Indices are essentially used for comparison purposes. They let you evaluate the performance of your portfolio versus how the market is doing in general. For example, if your portfolio contains mostly technology stocks, a good index to track your performance against would be the NASDAQ where most technology stocks lie.
An exchange is a marketplace, either physical or electronic, where financial products such as securities and commodities are bought and sold. The main goal of an exchange is to ensure fair, organized trading as well as efficient dissemination of price information for the securities on that exchange. An exchange may also be referred to as a “share exchange” or a “bourse”, depending on the location. The New York Stock Exchange and the NASDAQ are both exchanges.