Many of you have probably heard the term stock index, but you may not know what it means exactly. And if you have, it is worth reading the article, as I will cover countless subtleties in it. For example, whether it is realistic to compare the price of a stock to a stock index, do these indicators show the total return or not? How can an average investor benefit from this? All of this will be discussed in the article.
📈What is a stock market index?📉
The stock exchange index is a compound word, meaning that its parts can be defined separately, as the words stock exchange and index. The definition of a stock exchange is perfectly described by Wikipedia: “A stock exchange is a public, centralized, and organized market, a place where specified goods can be bought and sold by specified persons at specified times according to strict procedural rules.” In other words, the point is that you can buy and sell securities in a regulated environment and manner, and it is public, meaning anyone can do it.
📌Practical experience: Few people know that regulated capital market transactions take place on the stock exchange, so there are a lot of laws and institutions that protect what can happen on a real stock exchange. However, the word “stock exchange” is also used misleadingly for other things, such as trading crypto assets. These are not stock market transactions, even if the term implies that they are. This is important because you do not receive the same legal protections as you would on a real stock exchange.
An index is a point of comparison or reference for something, a benchmark, something against which we measure other things. For example, if an average man is 175 cm tall and 75 kg, then those taller than this are considered tall, and those shorter than this are considered statistically short.
Put the two words together and you have the definition. A stock index is the sum of the price changes of instruments of a given category traded on a country's stock exchange, which are formed according to specific rules. In fact, a stock index can be formed from anything, bonds, stocks, commodities, only papers of a given industry or sector, etc., but I will now refer to the stock index when I use the word stock index.
What stock market indices are there?
There are countless stock market indices in the world, usually several indices are created for the given market of a given country. Investors tend to follow indices created for the world's leading economies, not only because they may have interests in the given stock market, but also because their movements can be used to infer other economic processes. I will mention some of the better-known indices without claiming to be exhaustive:
🇺🇸US stock market index
- 📈DJIA (Dow Jones Industrial Average, USA): Dow Jones Industrial Average, one of the oldest American stock market indices with a century-long history, originally containing 12 companies, today this number is 30.
- 📈S&P 500 (Standard&Poor's 500, USA): the most frequently cited index, comprising more than 500 American companies. It is the most followed American stock index, next to the Dow Jones. The data here often serves as a general reference point for investors.
- 📈NASDAQ (USA): NASDAQ is an abbreviation for the stock exchange of American technology companies, and its index, the NASDAQ Composite. It was created in 1971 for companies that "didn't fit" into a formal stock exchange, which at that time were still typically technology companies. Today, you can trade not only stocks, but also ETFs, derivatives, and commodity products. Investopedia has a great video about how it works (NASDAQ overview).
I wrote a whole article about the US stock markets (American stock exchanges), this can provide a clue to understanding what kind of companies the indices listed above encompass and in what environment they operate.
🇪🇺European stock market indices
- 📈BUX index (Budapest Stock Exchange Index): A stock index comprising 30 Hungarian companies.
- 📈DAX index (Deutscher Aktienindex, German): also known as the Frankfurt Stock Exchange Index, which includes 40 German companies.
- 📈RTSI Russian Stock Exchange Index (Russian Trading System Index, Russian: Индекс РТС): an index of the 50 most significant Russian companies.
- 📈FTSE 100 index (Financial Times Stock Exchange, nicknamed "Footsie"): the London Stock Exchange index, the LSE, comprises the 100 largest companies listed on the London Stock Exchange, weighted by capitalization.
🇭🇺The concept of the BUX Index
Major international stock market indices
- 🇯🇵Nikkei (Japan): The Nikkei is the Japanese stock market index, which is an index of 225 companies. It is also worth looking at the price chart (Nikkei 225), because it rose a lot for years, then crashed in the early 90s, and only reached its previous peak in 2024, so it took 34 years to reach it.
- 🇨🇳Chinese stock market indices: There are basically two indices available in China, one for foreign and one for domestic investors. The former is the Shanghai Exchange, the latter is the Shenzhen Exchange, but there is significant overlap between the securities of the two exchanges, with many of the same securities listed. The Analysis Center wrote more about it here: Chinese stock market indices
- 📈Russell 2000/3000 (USA): An index that summarizes the price movements of 2000 and 3000 companies. The Russell 2000 summarizes small-cap companies, similar to the S&P Smallcap 600, but broader.
- 📈Wilshire 5000 (international): also called the total market index, it aggregates the price movements of 5000 international companies.
It is also worth mentioning that commodity products also have indices, a typical example of which is the Brent crude oil price index, which I have written about in two articles about the oil industry (OPEC, oil stocks, oil companies (2025) and Playing Oil with Oil Stocks (2025)There are countless other indices, and an index can have multiple interpretations, in the form of different financial products. For example, the S&P 500 includes GSPC, SPY (SPY), and the SP500TR tickers, more on these later.
📈How are each stock market index formed?
There are several major problems with stock market index formation, one of which is how companies are included and excluded, and on what basis the price aggregate is formed. A stock market can be price-weighted, market capitalization-weighted, and it is also an important question whether, for example, price weighting is calculated with a simple arithmetic average or in some more tricky way. The typical method these days is market capitalization-based weighting, such as the S&P 500, but there are counterexamples, such as the Nikkei and DJIA price-weighted indices. Let's look at a simple example of what the problem is with capitalization-based weighting.
Let's say we have 4 companies in our stock index, A, B, C, D. Each has a market capitalization of 1 billion USD, so they are worth 4 billion USD in total. This means that a change in the price of one company will change the value of the index by 25%. As another example, I randomly selected companies from the S&P500 list, which turned out to be: Microsoft (MSFT), 3M (MMM), Carnival Corp (CCL) and Aflac (AFL). Their market capitalizations are $1880 billion, $117 billion, $29 billion, and $38 billion, respectively, for a total of $2064 billion. Microsoft accounts for 91% of this, meaning that no matter where the other three stocks move, MSFT brutally dominates the index. This is an extreme example, of course, but in reality it is not much different.
🤯Mania in the stock market?🤯
This is especially true when there is some kind of mania in the stock market, for example, investors love the tech sector and their prices rise. Anyone familiar with the term FAANG, Facebook, Amazon, Apple, Netflix, Google, knows that when these stocks rocketed, which happened for about two-thirds of 2020, it didn't matter whether, say, the oil sector or banks fell, because they dominated the S&P 500 stock index so much that even this resulted in a positive average overall. The same thing happened from November 2022, when the price of NVIDIA (NVDA) increased by about tenfold and made it the second largest company in the world by market capitalization by 2024 and this is also true in June 2025. In the image below you can see the 20 largest publicly traded companies in the world, which you can view at any time on Finviz: Largest companies list
Another interesting fact is that the S&P 500 completely omits MLP-type companies (Why are MLPs ineligible to be in the SP500?), for which the index compilers did not even give an official explanation. There are other anomalies, but I will write about them in the following chapters.
In fact, the S&P 500 is also a float-adjusted index, meaning it is adjusted for the public share. This means that the index only takes into account shares owned by private investors, meaning that shares held by management, founders, the government, and other companies are not included.
Does the stock market index lie?
The answer is not at all clear, in some ways yes and no. The first problem is that you cannot invest in the stock market index. In other words, you cannot buy the stock market index, for this a financial instrument had to be created that tracks it. What is wrong with all financial products? It is that it has a cost, which obviously reduces the return, so it cannot produce 100% the same as the index.
The other problem comes from the fact that if you are thinking about an index-tracking ETF fund (We wrote about ETFs in this article: ETF meaning, purchase), then such ETFs buy all the stocks in the index, modeling its composition. The only problem is that not all brokers have direct market access, e.g. Forex and CFD brokers. Those who do not have direct access to the markets start tracking the index with some kind of derivative product, but there is no real security behind it, just a bet on the price movement, which will inevitably result in distortions.
Going back to the costs, no matter how low they are, they will result in significant differences in the long run. This will not be visible because before the 2000s, when passive investments started to become popular, there were not many ETFs, so they could not track the index, meaning there is relatively little data for backtesting, especially if you compare it to the entire 120-year history of the stock market.
Stock index price: what does it show?
Unfortunately, there are problems not only with the costs, but also with the yield display, where the underlying products are also the problem. I selected three stock identifiers, all three of which can be linked to the S&P500. (GSPC) is the identifier denoting the “general” S&P 500, (SP500TR) is the S&P 500 total return indicator. (SPY) is the ETF that follows the S&P 500, which in principle moves in the same way as GSPC, and indeed, based on the image below, the differences are quite small. SPTR draws the same curve, but is located much higher, what could be the reason for this? Let's look behind the scenes.
The stock index basically works by taking the prices, aggregating them, and then averaging them based on what the index is made of, the aforementioned average or weighted price method, and of course, how many shares are in it. However, the price increase is very different from the total return, which includes the return generated by dividends. The difference between GSPC and SPTR is that the latter is an index that includes a total return, which is why it has TR or Total Return in its name. In the picture above, I chose a relatively short period of 1 year.
The press always “knows” what is on the market
What would the press say about this? Something like: “The stock market has risen amazingly because of technology stocks.” This in itself is actually true, but there are relatively few dividend-paying stocks among them. About dividend-paying stocks here, I wrote about dividends in general here. Moreover, in such a short time frame, the main point is not visible, the effect of the dividend. But the average newspaper reader is not interested in this, they look at the graph, "well, this is going up a lot", then they run to buy something that is technology. In other words, GSPC can almost mislead anyone who only takes a glance at it.
That's why I drew the SPTR, and then I chose a much larger time frame, 20 years, because we invest in stocks for the long term, and wow, what you see has changed. Let's quantify it, in one year the difference is 2%, and in two decades it's 1050%. So the point is that you get a very different result if you use a total return chart and the time frame is long enough, so definitely keep that in mind.
Is the stock index graph linear or logarithmic?
The other tricky thing is that the scaling of graphing software can be set in various ways. How does such a chart work? On the X axis you see the elapsed time, depending on which the exchange rate can be followed on the Y axis, it is a clean line, everyone has seen this. Let's say the exchange rate climbs from 1000 USD to 2000, and then later from 3000 to 4000. This is a roughly linear process with small peaks and valleys, but if you convert it to a percentage, you get that in the first case the increase is 100%, and in the second it is only 25%. The difference in both cases is 1000 dollars, but the profit on the capital has decreased by a quarter. However, this will not be visible on the graph at first glance, the movement will be the same, since the scale shows fixed values.
Fortunately, most graphing programs can be switched to logarithmic, and Yahoo's to percentage, which will give you a much more realistic result. What does a logarithmic graph do? It doesn't use constant scale values on the Y axis, but instead uses the distance as a percentage change from the previous value. How does this work in practice?
Logarithmic is better than linear
Since investors are basically interested in percentage changes, these are also reported by various portfolio management and stock selection sites. In other words, when you look at the current price, which is, say, 100, if it increases by 5%, the price will be 105 USD by the end of the day. If the same stock were trading at 20 USD and also increased by 5%, it would be worth 21 USD by the end of the day. In terms of capital, this is exactly the same amount, only the quantified extent of the price change differs drastically. In other words, when you examine the price, always look at the percentage values alongside it, or change the scale to logarithmic. Anyone who would like to read more about the topic can do so in this article written by the Analysis Center: How the linear graph misleads
Stock index anomalies: the entry/exit effect
Adding or removing a stock from a stock index is just a technical issue, but this in itself can cause anomalies. A very good example of this is the inclusion in the S&P 500 index when the price of the included securities increases. Why does this matter to the average investor, beyond the prestige of course? The answer is very simple: if an index-tracking fund or ETF wants to track the S&P 500, it has to buy the stocks included in it. This generates pressure on the buying side and raises the price. The same is true the other way around, if a company drops out of the index, it has to be sold, otherwise they would not meet the selection criteria of the investment fund or ETF.
This will drive the price down, as it generates selling pressure on the stock. Several studies have been conducted on the effect of inclusion in the index, e.g. one was conducted in 1996 (An Anatomy of the S&P Game), and showed these types of connections. The latest research I found on this subject was detailed in a study affiliated with Tilburg University (Prof. Dr. Oliver Spalt: The S&P 500 inclusion and exclusion effect), which covers the period 1995-2018.
S&P 500 stock index conditions
How to get into the S&P 500? A company must meet the following criteria (originally here):
- its market capitalization is at least 14.5 billion USD (as of June 2025)
- its headquarters are in the USA
- their shares are traded on the stock exchange annually at least as much as their market capitalization
- at least a quarter of a million shares changed hands in the previous 6 months
- the majority of its shares are held by private investors
- at least 1 year has passed since its IPO
- the company was profitable in the previous 4 quarters
A good example of this is Tesla (TSLA), who joined in October 2020. Also, Exxon Mobile (XOM), which was removed then, but has since returned, so it is not at all uncommon for some companies to drop out periodically.
What is the problem with the above? According to the “Efficient Markets Theory”, the price of a security fully reflects available information (Efficient Markets Theory), so the different effects are priced in. Therefore, in principle, there are no irrational pricing, but in reality there are, and rational and irrational decisions neutralize each other's effects, and the price is constantly in equilibrium.
Inclusion in a stock index does not change the fundamental values of the company, meaning it should be completely irrelevant whether it is included in the index or not. Therefore, inclusion and exclusion should not, in principle, affect the price. However, studies show that there is a correlation between the content of the stock index and the price of the companies included in it. I heard from several people in 2020 that if Tesla were included in the S&P 500, its price would definitely go up. In comparison, the stock fell 6% that day (Tesla enters the SP500), so this is quite speculative, it's not necessarily a good idea to base it on this. Of course, looking back from mid-2025, no one cares about this anymore, as the company has been through countless ups and downs since then.
📌In practice: the above is almost always theoretical stuff, 99% of investors are not aware of this knowledge. Since most investors investing in index ETFs are not interested in these subtleties at all, they only want the nominal return of the US stock market of around 9.5% for years, expressed in dollars, they simply do not care about the details. And they are partly right, in the 10-20 year term, what will matter is whether you are able to hold the ETF that tracks the index or not. If you do, you can almost certainly expect a profit, so you do not have to worry about the specifics of the stock index!
How do we use the stock market index?
The best-known stock market indices are the S&P 500 (The essence and use of the SP500 index), so if someone uses the word “stock index” in general, they are usually referring to the American stock market or the S&P 500 index. There are a lot of theories and techniques associated with the stock index itself. When someone makes statements like this that this or that will happen on the stock market in a 10-20-30 year time frame, they are actually always referring to the given stock index. In many cases, the average metric of the indices is taken as a reference point, not only in terms of price, but also in stock analysis, for example.
For example, if you hear that the average dividend yield of the S&P500 is 1.27% (S&P 500 dividend yield), what they were saying was that if you averaged the dividend yields of all the stocks in the index, including those that don't pay dividends, you would get the above number. This reference point is good for things like Philip Morris (PM) has a higher than average dividend yield because it pays ~3%. One could list a hundred more such indicators, the point is that it is possible to conclude about the deviation of individual companies from the average.
What do the indicators show?
I would like to mention two more things, one is the comparison with the valuation ratio of the stock market index. The P/E ratio provides information about how the price of companies relates to the earnings per share they generate. If the P/E is high, the company may be overvalued, if it is low, then it may be undervalued, I wrote more about this in a previous article (Interpretation of balance sheet and income statement). When you hear or read that “the market is expensive,” they are usually referring to the S&P 500 P/E average. This is currently, at the time of writing, a historically high 28, but you can check the indicator on Macrotrends (S&P500 PE ratio). If you look at a company that has a lower price than this, it is considered cheap compared to the market as a whole. What does this mean in practice? Nothing in the world, but you can write sensational headlines on economic portals. Such aggregate indicators should not be taken too seriously, you should always look at why it is so high and what the reason is.
The other is the beta indicator related to market volatility. People usually write things like “the stock market is very volatile” or “there is a lot of volatility in the markets”. These sentences mean that for some reason the price of the stock market index is jumping, but this does not mean that the price of individual stocks is also jumping. The beta indicator is good for this, which measures volatility compared to the SP500 index. In the case of the index, it is 1, so anything smaller than this, e.g. the utility sector is less volatile. If it is larger, as in the case of Tesla (TSLA), the stock will have a larger price movement. This is also called correlation, which means how much an instrument moves together with the stock market index.
📌In practice: Many people fear volatility because it is equated with risk, but this is not true. A volatile stock price has many entry and exit points, meaning that investors who are sufficiently calm can get their hands on the stock at a lower price. Volatility becomes a risk if for some reason you are forced to sell the amount invested in the stock. If its price is going down, you will suffer a loss. Of course, the opposite is also true; if it is going up, you will realize a profit.
Beta or correlation?
Regarding the beta indicator, it is worth noting that its value also expresses deviations, the amplitude. Its value can be greater than 1, in which case it moves together with the index, but by a greater percentage. In contrast, the correlation can only take values between 1 and -1.
To summarize the correlation:
- if the correlation is 1, then the instrument moves together with the index
- if the correlation is 0, then there is no relationship between the instrument and the index
- if the correlation is -1, then the instrument and the index move in opposite directions
There are typical markets that have low correlation, for example gold, which is often used as an argument for “investment” because the short-term correlation index is 0.25, meaning that there is little relationship between the price movement of gold and the movement of the stock market index. However, if you look at other time frames, you get completely different results. The 50-day moving average is -0.23 and -0.46, which already assumes that the correlation is close to zero or negative. In theory, you can use this to prevent anyone from rushing to buy gold now, so that if the stock market rises, you lose gold, and if it falls, you sell it and realize the swings.
Stock index strategies
In this section, I will just write a few examples of stock index strategies in general, as I am not an expert on the subject, but I will outline the basics. The following strategies have been observed based on longer backtests and historical events, but their application requires a lot of research. These are basically speculative techniques and require active management, so just use common sense.
Stock index strategies can be most easily traded with ETFs, which are exchange-traded funds, but there are other, shorter-term instruments, but let's stick with ETFs for now. For example, a sector rotation would be quite tricky to implement by buying individual stocks, but if that doesn't scare you off, the costs will.
💡It is important to note that there is relatively little evidence for the following strategies. Sure, studies have been done and back-tested for specific periods, but this does not mean that they will work in the future.
Sector rotation and seasonality
The essence of sector rotation can be guessed from the name, investors buy a financial instrument that covers a given sector or industry, but let's stick to ETFs from now on. The strategy is based on the fact that economic cycles repeat one after another. Individual sectors sometimes perform better and sometimes worse in this cycle, and investors always rotate their capital to the one that is currently in a winning position. TackleTrading has a good article about this (TackleTrading Newsletter), if someone wants to delve deeper into the topic. In the article, the author also presents the application of the method based on sectoral ETFs. You can roughly guess what stocks they contain from the names of each ETF, e.g. XLB represents raw materials, XLF represents the financial sector, while XLE represents the energy sector.
source: Tackle Trading
🏖️Everyone loves summer and Christmas🎅
Trading on special days: You may have heard of the "sell in May and go away" strategy (Sell in may and go away), which means you sell your positions in May, go on vacation, and come back at the end of October. These high-sounding words are usually invented by stock traders, such as the name “rocktober” because it sounds really cool and suggests that you can make a lot of money that month. There are also notable days that are great for trading an instrument that tracks a stock index:
- Before and after Christmas: It's also called the Santa Claus rush, and there have been countless explanations for why you can outperform average returns around Christmas. I think people are just getting carried away and bored, but there are a lot of studies on this that are worth looking at.
- Pre-Holiday effect: There was an interesting table on Stockharts about it, which includes the pre-holiday returns, which are of course much higher than the average returns. These are of course related to American holidays, and there are some that are completely unknown in Europe, for example.
- Sell in May and go away: The essence of the aforementioned strategy is that there are months where statistically demonstrable excess returns can be realized. The November-May half-year is such a period, and the strategy is based on this.
👁️🗨️The power of the moment
Momentum strategies: The literature knows all kinds of momentum strategies (Momentum Investing), absolute, relative, etc. but now I will write a few words about them in general. The essence of momentum strategies is that traders buy a stock whose one of the indicators is growing rapidly, this is called momentum. This is usually 3, 6, 12 months, but always some kind of short-term strategy, so the stocks are not held for decades. The selection of these is typically based on technical analysis, but there are also fundamental bases, such as: CANSLIM. The securities needed to apply the momentum strategy are selected by, for example, dividing the entire market into 10 parts in terms of growth, for example based on the 50 or 200-day moving average, and buying the most outperforming ones. The goal here is also to outperform the index, and there are ETFs for this too: Momentum ETFs
Buying market indices of cheap countries: In fact, the essence of the strategy is in its name: you have to buy the entire market that is cheaper than the others. How can you do this? You have to buy the instrument that tracks the stock market index, and that's it.
Stock index topic summary
As short as I thought the stock index topic would be, the article has become so long. What I would definitely like to draw your attention to is that the index itself can be used as an indicator, if you know what to look for. Pay attention to which index you use, how it is formed, and how the charting programs display the price. Those who buy ETFs will find this type of information particularly useful. Moreover, using ETFs is one of the most obvious things for the average investor, we wrote about this in detail in another article: ETF meaning and usage
Frequently Asked Questions (FAQ)
ETF meaning
ETF stands for exchange-traded fund, an investment vehicle that tracks a specific index, commodity market, bond basket or other asset class and is traded on the stock exchange like a stock. The advantage of ETFs is that they offer diversification, as they invest in multiple assets, low costs, and liquidity, as they can be bought and sold just like a stock. A typical example is an S&P 500 ETF, which tracks the American S&P 500 index, allowing us to invest in the performance of 500 large companies with a single transaction. Perhaps the best-known of these is the ETF with the SPY ticker.
CFD meaning
A CFD (Contract for Difference) is a derivative financial instrument that allows an investor to speculate on the price of an asset without actually owning it. The essence of a CFD is that the difference between the buying and selling price, i.e. the profit or loss, is settled between the broker and the investor. CFDs can be traded on stocks, indices, currencies, commodities, and are often leveraged, which increases profits but also risks. Since there is no actual ownership, a CFD is more suitable for short-term, speculative trading.
Forex meaning
The Forex (Foreign Exchange Market) is the world's largest and most liquid financial market, where currencies from different countries are traded. Forex trading involves investors selling one currency while buying another, for example, buying euros for US dollars (EUR/USD). Exchange rates in the market are determined by supply and demand, and typically involve leveraged transactions, which can result in larger profits or losses with a small investment. The Forex market operates 24 hours a day, with the participation of mainly banks, institutions, brokers and speculators.
Graph meaning in stock market terms
In stock market terms, a chart is a visual representation of the price of a financial instrument, such as a stock, index, currency, or commodity, over time. It allows investors to track past price movements, identify price trends, breakouts, or reversals, and perform technical analysis. The most commonly used charts include the line chart, the bar chart, and the candlestick chart, the latter of which provides detailed information about the opening, closing, high, and low prices for a given period. It is typically used in technical analysis.
Meaning of inclusion, meaning of exclusion
Inclusion means inclusion. It means that a company is added to the index, for example, if a company grows large enough, is liquid, and meets the index requirements, the S&P 500 committee may decide to include it. Inclusion often results in a price increase, as ETFs and funds that track the index automatically buy the stock.
Exclusion means removal. It means that a company is removed from the index, for example because its market value has decreased, it has gone out of business, or it no longer meets the criteria. Exclusion often results in a price drop as index tracking funds sell the stock.
Inclusion/exclusion can therefore trigger significant market movement and is an important event for investors and traders.
S&P 500 meaning
The S&P 500, or Standard & Poor's 500 Index, is one of the most important and well-known stock market indices in the United States, tracking the performance of 500 large-cap American companies. The index aims to provide a comprehensive picture of the entire American stock market, as the companies included in it cover many sectors of the American economy, such as technology, finance, healthcare, industrials, and energy.
The S&P 500 is capitalization-weighted, meaning that companies with larger market capitalizations, such as Apple, Microsoft, or Amazon, have a greater impact on the index's movements. The index is compiled by financial services company Standard & Poor's and is considered one of the most important measures of market performance worldwide.
Nasdaq report
Nasdaq is one of the largest electronic exchanges in the United States, where stocks of primarily technology companies are traded. It was launched in 1971 and was the first fully computerized, electronic stock exchange system. Shares of companies such as Apple, Microsoft, Google, Amazon, Nvidia are traded here.
- The Nasdaq Composite tracks the performance of more than 3 companies listed on the Nasdaq stock exchange.
- The Nasdaq-100 includes the largest non-financial companies listed on Nasdaq, such as Tesla, Meta, Netflix, etc.
Index concept
A stock index, or simply index, is a statistical measure that tracks the average price movement of a selected group of stocks, such as the largest companies in a country. It aims to provide a broad picture of the performance of a given market or sector.
The index is typically calculated based on a basket of stocks compiled according to a specific set of rules and can be a simple average or, as in most cases, weighted by market capitalization. Well-known indices include the American S&P 500, the German DAX, or the Hungarian BUX. Indices are also often used by investment funds, ETFs, and analysts to compare market sentiment or returns.
Index fund concept
An index fund is an investment fund that attempts to replicate the composition and performance of a given stock market index. This means that the fund holds the same stocks as the index, such as the S&P 500 or BUX, and in the same proportion, so its return is aligned with the return of the index.
Index funds are passively managed funds, meaning they don't try to "beat" the market, but rather follow it. As a result, such funds have low costs, are simple to operate, and often provide better returns over the long term than actively managed funds, although this is due to costs. They can be an ideal choice for beginners or long-term, cost-effective investors.
Whatever you invest in, you will definitely need a broker.
Which broker should I choose to buy shares?
There are several aspects to consider when choosing a broker - we will write a complete article about this - but I would like to highlight a few that are worth considering:
- size, reliability: The bigger a broker, the safer it is. Those with a banking background – Erste, K&H, Charles Schwab, etc. – are even better, and well-known brokers are typically more reliable.
- expenditures: Brokers operate with various costs, such as the account management fee, the portfolio fee - which is the worst cost -, the purchase/sale fee and the currency exchange cost (if USD is not deposited in the brokerage account)
- Availability of instruments: It doesn't matter which broker has which market available, or whether they add the given instrument upon request and how quickly.
- account type: cash or margin account, the latter can only be used for options. For Hungarian tax residents, having a TBSZ account is important, but citizens of other countries also have special options – such as the American 401K retirement savings account – which are either supported by the broker or not.
- surface: is one of the most underrated aspects, and it can be a real pain. Anyone who had an account with Random Capital, a now-defunct Hungarian broker, knows what it's like to work on a platform left over from the 90s. Erste's system is lousy slow, Interactive Brokers requires a flight test, and LightYear believes in simple but modern solutions.
Based on the above, I recommend the Interactive Brokers account because:
- the world's largest broker with a strong background
- a few million instruments are available on it, and shares listed on multiple markets – e.g. both the original and the ADR – of a single share are often available
- Interactive Brokers a discount broker, they have the lowest prices on the market
- you can link your Wise account to them, from which you can quickly transfer money
- Morningstar's analyses are available for free under the fundamental explorer (good for analysis)
- EVA framework data is available under fundamental explorer (useful for analysis)
- they have both cash and margin accounts, Hungarian citizens can open a TBSZ
- you can use three types of interfaces: there is a web and PC client and a phone application
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