Market Indices Explained

An index is a rule, not a market

A market index tracks the combined performance of a defined list of stocks according to a published methodology. Someone wrote the rules: which companies qualify, how they are weighted, how often the list is reviewed and what triggers a removal. The index number is the output of applying those rules, which makes an index a measuring instrument with a design, not a neutral reading of the market.

That matters because the design decides what the number actually measures, and the most consequential design choice is weighting.

When the top ten names carry 35% of the index

In a capitalisation-weighted index, each company’s influence is proportional to its market value. Suppose a 500-company index where the ten largest members account for 35% of total weight, which is not an unusual concentration.

In the equal-weighted version each of the 500 members carries 0.2% of the index, so those same ten names carry 2% in total and a 10% fall in them moves the index 0.2%. The two indices track the same companies and can report materially different years.

The practical reading is that a headline index level is a statement about its largest members. When a cap-weighted index is up 12% and the equal-weighted version of the same list is up 2%, the market did not rise; a handful of very large companies did.

Concentration is also not static. It builds over time by construction: a company that rises gains weight, which gives it more influence over the index, which is then reported as market strength. Cap weighting is a momentum rule wearing the costume of a neutral average, and the periods when the top-ten weight is highest have historically been the periods when that concentration mattered most.

Cap-weighted, price-weighted and equal-weighted

• Capitalisation weighting sets influence by company value. It is the most common method, it requires no rebalancing as prices move, and it concentrates into whatever has already risen.
• Price weighting sets influence by share price alone. A $500 stock has ten times the influence of a $50 stock regardless of which company is larger, and a stock split mechanically cuts a member’s influence with no change to the business.
• Equal weighting gives each member the same share. It requires regular rebalancing, tilts towards smaller members, and behaves quite differently in a market led by mega-caps.

There is also a float adjustment inside most cap-weighted indices. Weight is based on the shares available to public investors rather than every share issued, so a company where a founder or a government holds 60% of the register counts at 40% of its nominal size. This is why a company’s index weight and its market capitalisation ranking do not always agree.