Stock indexes are formed based on the kinds of stocks or financial securities they want to track. For example, the Standard & Poor's 500 (S&P 500) index tracks large cap stocks, while the Dow Jones Industrial Average (DJIA) tracks large cap industrial stocks. For a stock to be added to an index, it must meet a list of guidelines. Depending upon the scope of the index, each index will have its own requirements for component eligibility. For example, the Wall Street Journal maintains the DJIA and one requirement is that the stock be "of interest to a large number of investors". In addition, two common requirements for component selection are that the stock must be relevant to the scope of the index and that the stock must meet all Securities and Exchange Commission (SEC) rules.

If the stock does not adhere to the requirements set out by the organization maintaining the index, the stock will not be added. For example, the S&P 500 will not add a stock that does not meet its large cap requirements. Similarly, if a company is an existing component of the index, but a material change to the company has occurred, it will get pulled from the index. Further, a component company will be removed if it has been acquired and no longer is traded publicly. The indexes also make sure that the companies they add meet all SEC guidelines. If a company violates a SEC rule or is known to have defrauded investors, that company's stock is pulled from the index. In other words, for a company to be added to an index, the company's stock has to be relevant to the purpose of the index and the company must be in full compliance with securities regulations. (To learn more about indexes, see Index Investing and Is it possible to invest in an index?)

This question was answered by Chizoba Morah



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