Highlights
- An index is a summary statistic, and three construction choices explain almost every behavioural difference between benchmarks.
- Weighting method decides whose movement counts. Capitalisation, price and equal weighting produce very different pictures of the same market.
- Sector composition determines what an index is genuinely exposed to, which is often not what its country name suggests.
- Currency exposure can dominate returns for international investors, sometimes reversing them entirely.
- Comparing index performance across countries without adjusting for currency and composition produces conclusions that are simply wrong.
What an Index Actually Measures
An equity index combines the value of a group of listed companies into a single number. It is a convenience, and like every convenience it discards information.
The discarded information matters. Two indices covering the same country can move in opposite directions on the same day because they contain different companies weighted differently. An index can reach a record high while the median company within it trades well below its own peak.
Our coverage of world indices follows the major global benchmarks, and this guide explains how to interpret them rather than simply read their levels.
The Three Construction Choices
Weighting Method
Capitalisation weighting gives each company influence proportional to its total market value. This is the most common approach and it concentrates influence heavily in the largest constituents. The S&P 500, Nasdaq Composite, FTSE 100, DAX and most global benchmarks use it.
The practical effect is that an index containing five hundred companies can behave like an index containing twenty, because the largest twenty carry most of the weight.
Price weighting gives influence based on share price alone, regardless of company size. A company with a high share price and modest market value exerts more influence than a much larger company whose shares happen to trade at a lower price. The Dow Jones Industrial Average and the Nikkei 225 both use this method, which has no modern statistical justification and survives on tradition.
Equal weighting gives every constituent the same influence. Equal weighted versions of major indices exist and are genuinely useful, because comparing them with the standard version reveals whether market strength is broad or narrow.
Sector Composition
An index is ultimately exposed to whatever its constituents do, and country labels frequently mislead.
The FTSE 100 is a London listed index in which a large share of revenue is earned abroad, weighted toward energy, mining, banking and consumer staples. It functions more as a global commodity and currency exposure than as a measure of the British economy.
The DAX is industrial and export oriented, which ties it to global trade and manufacturing demand. The CAC 40 leans toward luxury goods and aerospace. The ASX is dominated by mining and banking. The Nasdaq 100 excludes financial companies entirely.
Before comparing two indices, check what they actually contain. The differences usually explain the divergence.
Currency Exposure
For any investor holding an index outside their home currency, returns combine the index movement and the exchange rate movement.
A benchmark rising ten percent in local terms while its currency falls ten percent against yours produces roughly nothing. This effect is large enough to reverse apparent outperformance, and it is routinely omitted from cross country comparisons in financial media.
The Major Benchmarks in Brief
United States
The S&P 500 covers five hundred large companies selected by committee, with a profitability requirement, and is the standard reference for US equity performance.
The Nasdaq Composite includes thousands of Nasdaq listed shares and is technology dominated in practice rather than by rule. The Nasdaq 100 covers the hundred largest non financial constituents.
The Dow contains thirty companies weighted by price. The Russell 2000 tracks around two thousand smaller companies and is widely read as a gauge of domestic economic health and credit conditions.
Europe
The FTSE 100 covers the largest London listings. The DAX covers major German companies. The CAC 40 covers France. The Euro Stoxx 50 aggregates leading eurozone companies, while the STOXX Europe 600 offers much broader coverage across large, mid and small capitalisation firms in seventeen countries.
Asia Pacific
The Nikkei 225 is price weighted and heavily influenced by the yen, since a weaker currency lifts exporters. The Hang Seng reflects both Chinese corporate performance and international sentiment toward China. The NSE Nifty 50 covers India’s largest listed companies. The ASX carries heavy mining and banking weights. The Shanghai Composite tracks mainland listings within a distinctive regulatory environment.
How to Compare Indices Honestly
Comparing benchmarks properly requires four adjustments that are usually skipped.
Convert to a common currency. Otherwise you are measuring exchange rates as much as equities.
Check whether returns include dividends. Price indices exclude them, total return indices include them, and the difference compounds substantially over years. Many widely quoted indices are price versions, which understates actual investor returns.
Compare sector composition. An index heavy in technology outperforming one heavy in energy tells you about sectors, not countries.
Use the same time period and starting point. Start dates chosen after the fact can demonstrate almost any conclusion, which is why they are chosen after the fact so frequently.
What Record Highs Actually Mean
A record high means only that the index is above its previous peak. It carries no predictive information in either direction.
Indices that generally rise over long periods spend a substantial share of their time near record levels, which makes the milestone unremarkable. It is also not a signal to sell, since markets in uptrends set repeated records by definition.
The more useful questions are whether the advance is broad, whether valuations have expanded beyond earnings growth, and whether leadership has narrowed to a small group.
Index Inclusion and Exclusion
Being added to a major index forces every tracking fund to buy, which can move the share price ahead of the change. Removal forces the reverse. These flows are mechanical rather than judgements about business quality.
Reconstitution schedules are published in advance. The Nasdaq 100 rebuilds annually in December. The Russell indices reconstitute annually. The S&P 500 changes on an ongoing basis through committee decision.
Using Indices as a Benchmark
Choose a benchmark that matches what you actually hold. Comparing a globally diversified portfolio against the Nasdaq 100 will make you feel terrible in some years and euphoric in others, without telling you anything useful about your own decisions.
The right benchmark reflects your asset mix, your geographic exposure and your currency. Anything else measures the wrong thing.
Summary Keys
- Indices are summaries shaped by weighting method, sector composition and currency exposure.
- Capitalisation weighting concentrates influence in the largest constituents, so constituent count overstates diversification.
- Country labels mislead, since many national indices derive most revenue abroad.
- Currency movement can eliminate or reverse apparent outperformance for international holders.
- Honest comparison requires common currency, consistent dividend treatment, matched sectors and identical time periods.
- Record highs carry no predictive information and are a normal feature of long term uptrends.
Frequently Asked Questions
Why do two indices covering the same country move differently?
Because they contain different companies weighted by different methods. An index of thirty large companies weighted by share price will behave quite differently from one containing two thousand smaller companies weighted by market value, even within the same economy. Sector composition compounds the difference, since a benchmark dominated by banks responds to interest rates while one dominated by miners responds to commodity demand.
Should I follow the price index or the total return index?
Total return, if you are assessing investment outcomes, because it includes reinvested dividends. Most headline index levels quoted in the media are price versions, which exclude them. Over long periods the difference is substantial, particularly for income heavy benchmarks such as the FTSE 100 where dividends have historically contributed a large share of total return.
Is a broad index automatically well diversified?
Not necessarily. Because most major indices are capitalisation weighted, a small number of very large companies can account for a disproportionate share of movement even when hundreds or thousands of constituents are included. Comparing the standard index with its equal weighted version reveals how concentrated the exposure actually is.
Where to Go Next
This guide expands the index section of our complete markets framework, which covers every asset class, the global trading day and what drives prices across all of them.
