What an index is

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The DSEX rose 100 points: what actually went up?

What is an index?

A market has hundreds of shares. On any day some rise and some fall. Looking at each one separately, it is hard to say “how did the market do today”. A stock index makes this easy: it combines the prices of many selected shares by a set rule into one number. When the number goes up, those shares have, taken together, gone up in price.

The index number has no value in taka by itself. A base number (such as 1,000) is chosen on a starting day, and what matters is the percentage change from there. So knowing “by what percentage it rose” is more useful than hearing “it rose 100 points”.

An example

An index works like the “basket” used to measure inflation. Say you write down the prices of rice, lentils, oil, onions and eggs every week and combine them into one number. In a week when onions jump but eggs fall, the total might rise only a little. A share index does the same with company shares instead of groceries. The example is only to explain the idea.

Why it matters to an investor

To take the market’s temperature: an index shows whether the market is generally buoyant or depressed, without checking each share.
To compare your own results: your shares or fund rose 5% in a year; if the index rose 15% over the same time, you actually lagged the market. The index is the yardstick, or benchmark.
To understand index funds: index funds and many ETFs copy an index exactly. Without knowing how the index is built, you cannot tell what the fund is buying.
To read the news properly: an index can rise while most shares fall, if a few large companies rise a lot.

How it is calculated: weighting is everything

The key question is how much “weight” each share gets in the index. The oldest method is price-weighting: the higher a share’s price, the more weight it carries. The US Dow Jones Industrial Average works this way; it was first published on 26 May 1896 with just 12 companies, and has had 30 since 1928. Most major indices today are market-cap-weighted: the larger a company’s total market value, the more weight it carries.

One step further is free float: weights are calculated only from shares that actually circulate in the market, leaving out those held by sponsors, the government or strategic owners that usually do not trade. DSE’s old general index, the DGEN, counted all shares. When a very large company listed in 2009, that index jumped more than 764 points in a day, causing confusion in the market. New free-float indices followed.

Bangladesh’s main indices

DSEX: DSE’s main or “broad” index. Designed by the international index provider S&P using the free-float method, it launched in January 2013. At launch it held 199 companies, about 93% of market value then. It closed its first day at 4,090.47 points.
DS30: an index of 30 large companies, launched at the same time. Members are chosen on profitability, market value and similar measures, and reviewed every six months.
DSES: a Shariah-based index, running since January 2014 from a base of 1,000 points. It is a subset of the DSEX that leaves out businesses such as alcohol, pork products, gambling and weapons; in 2023 it held about 70 companies.
CSE’s indices: the Chittagong Stock Exchange’s all-share index, CASPI, is the one most often in the news. Its points are a much bigger number than the DSEX’s because its base and method differ; the two indices’ points cannot be compared directly.

What an index does not tell you

Dividends: a price index such as the DSEX looks only at prices. Counting dividends, investors’ total return is usually somewhat higher than the index shows.
Your own result: your portfolio does not hold the index companies in the same proportions, so your shares can fall while the index rises.
Whether the market is cheap or dear: an index at 5,000 or 7,000 does not tell you whether prices are high or low relative to companies’ earnings.

Worked example

Same price rise, two kinds of index (only to illustrate)

Say a market has three companies. A: price Tk 200, 10 lakh shares, market value Tk 20 crore. B: price Tk 20, 50 lakh shares, market value Tk 10 crore. C: price Tk 50, 40 lakh shares, market value Tk 20 crore. Total market value: Tk 50 crore.
A’s price rises 10% (to Tk 220). Price-weighted index: the sum of prices goes from 270 to 290, up about 7.4%. Market-cap index: total market value goes from Tk 50 crore to Tk 52 crore, up 4%.
If instead B rises 10% (to Tk 22): the price-weighted index goes from 270 to 272, up only 0.74%. The market-cap index goes from Tk 50 crore to Tk 51 crore, up 2%.

Result: how much the same 10% price rise moves an index depends on the index’s weighting rule. In a market-cap index, moves in large companies matter most. The numbers are only an example.

Common mistakes

Thinking “the index rose, so my shares must have too”. The index is an average, not your portfolio.
Getting excited or alarmed by points. 100 points from 4,000 is 2.5%; from 8,000 it is 1.25%.
Treating an index’s long-run change as total return. A price index leaves out dividends.
Comparing points across different indices, such as “CASPI is far higher than the DSEX”. With different bases, comparing points means nothing.

Remember

An index is a yardstick built from many share prices: watch the percentage, not the points, and remember it is the market’s average, not your portfolio.