Traders just getting into stock market indices may notice a lot of different terms used to define them, such as small cap, equal weighted, growth index and many others. All these names are used to define what types of stocks make up an index to facilitate market analysis for traders.

In this article, we’ll help you outline the main types of indices and their differences.

Let's start with one of the most common ways to categorise indices – by the weight of stocks within them.

Weighted indices

There are three types of indices by weight:

Market capitalisation-weighted indices

A company's market capitalisation means its value on a market. It can be calculated by multiplying the total number of outstanding shares (all the shares it has ever issued) by the share price.

For example, if company A has 100,000 shares priced at USD 20, its market cap is:

100,000 X 20 = USD 2,000,000

If an index is weighted by market cap, it means that the companies with a higher market capitalisation or value are given more weight. Simply put, higher valued companies have more importance in a market cap-weighted index. For example, if the index value is USD 500 million, a company worth USD 100 million will make up 20% of the index value. Price movements of this company have more effect on the index than a company with a USD 10 million market cap.

Market cap indices are the most common because they provide a clear and accurate way of evaluating stocks within an index. It also makes the performance analysis of an index much easier, as it is based on stocks’ true value. Almost all the top-traded indices we discussed in our previous What is a stock index article are weighted by their market cap – S&P 500 (SPX 500), Nasdaq 100 (NAS 100), FTSE 100 (UK 100), DAX 40 (GER 40) and Nikkei 225 (JPN 225).

However, most of these indices list stocks by free-float market capitalisation. It means that the company’s market cap is calculated by taking into consideration only the publicly held shares, ignoring the privately owned ones.

Price-weighted indices

The companies within price-weighted indices are given weight according to their current share price. The most expensive shares will have more importance compared to the lower-priced ones. For example, a company with a share price of USD 1,000 will have a much stronger effect on the index performance when its price fluctuates compared to a company with USD 100 shares.

The Dow Jones (US 30) index is one of the most popular examples of a price-weighted index.

Price-weighted indices are less common than market cap ones because stock prices are not always an accurate indication of their true value.

Equal-weighted indices

This way of calculating indices is the most intuitive – each company carries equal weight, value and importance, regardless of the company's size. Simply put, in an index made up of 100 companies, each company represents only 1% of the overall index's price.

Equal-weighted indices are quite popular among traders because they don't depend on the largest stocks as much as the market cap indices, which reduces the risk for traders.

Keep in mind that some indices can have several variations. For example, the S&P 500 is commonly used as a market capitalisation-weighted index, but there is also a lesser known, equally weighted version. This equal-weighted S&P 500 is tracked under a different ticker and has the same list of companies, but they are given a fixed weight.

Market capitalisation indices

The market-cap indices can be further divided into three smaller groups:

Large cap indices – over USD 10 billion
Mid cap indices – USD 2 – 10 billion
Small cap indices – USD 300 million – 2 billion

This method of index classification is also very popular among traders as it gives an immediate indication of the index’s nature. You’ll often see it in the name of the index right away, for example, Russel Mid Cap 2000 index (US 2000). If you don’t see any indication, it implies that the index is a large cap, like all the most popular indices we’ve mentioned above.

Indices by geographical affiliation

On a wider scale, indices are usually divided by the geographical location of the companies included in them.

Global (worldwide) indices track stocks from all over the world. For example, the MSCI world index consists of stocks from 23 countries.
Regional indices consist of stocks of a particular region. The Euro Stoxx 50 index (ESTX 50), composed of 50 blue-chip companies from 11 countries of the Eurozone, is one good example of a regional index.

It's worth mentioning that there are indices that are somewhat similar to regional, but they combine stocks from various locations based on the economic advancement of their country of origin – developed or emerging.

National indices are made up of stocks of the same country. These indices are the most popular and heavily traded because their performance is correlated with their respective country’s economic growth, making it easier to evaluate and identify trading opportunities. That’s where the top-traded indices from our list belong, among many others.

National indices, along with the sectoral ones, are often used as a benchmark – a standard to measure the performance of other indices against, as they usually include the best-performing stocks of their category.

Sectoral indices

This classification is popular among traders because companies that belong to the same economic sector are usually influenced by the same factors and perform similarly, making the analysis easier.

According to the Global Industry Classification Standard, there are 11 official stock market sectors:

Financials
Healthcare
Energy
Materials
Utilities
Industrials
Real estate
Consumer discretionary
Consumer staples
Information technology
Communication services

Indices by stock types

Value indices are made of stocks that tend to preserve value, combined with slow but steady growth, resulting in very low volatility. Due to reduced trading opportunities, these indices are rarely of any interest among day traders. However, they are often appreciated by long-term investors.

Growth indices consist of companies with above average sales growth and may experience periods of high volatility. The most traded stocks usually belong to this category.

Islamic indices

Besides the outlined common types of indices, analysts often segregate Islamic indices into a separate category. These indices can be further categorised following the same logic as other indices, but they only include stocks of the companies that comply with Sharia law. However, due to some limitations and controversies, these indices are more popular among long-term investors than active traders.

It's important to check some basic information about an index before you start trading it, as it can help you evaluate future price movements and identify trading opportunities. In market cap and price-weighted indices, for example, you'll need to pay closer attention to factors affecting the largest and most expensive stocks as they affect the overall price of the index. On the other hand, equal-weighted indices are more sensitive to factors affecting their overall performance. National indices will heavily depend on the economy of the country they belong to, sectoral on a sector and so on. Now let's see what can affect stock market indices' price movements.

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