A stock market index is a way of calculating a particular section of the stock market. It is calculated from the current prices of some selected stocks.
It is a tool that is used by investors and experts in financial market to describe the current situation of the market, and compare its return with specific investments.
The primary characteristic of a good index that will draw investors to it IS that it is investment and transparent.
The difference between the performance of an index fund and the actual index is called tracking error.
Market indices measure the value of groups of stocks. For instance, if an index goes up or done by a particular value, this means that the corresponding value of stock will go up or down by the same value; thus becoming either more attractive or less attractive to investors.
How indices help investors
Indices indicate the financial level of an industry where an investor has invested. So if the DJIA drops at a time or continues dropping over a given period of time, for instance, the investor might come to a conclusion that some of its companies are in trouble. This may push him to have a reassessment of his portfolio and look for other companies to invest in.