How do indexes determine which stocks are removed or added to them?

By Chizoba Morah AAA
A:

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

RELATED FAQS

  1. What are unregistered securities or stocks?

    Before securities, like stocks, bonds and notes, can be offered for sale to the public, they first must be registered with ...
  2. How does FINRA differ from the SEC?

    With all the financial organizations out there, knowing what they all do can be as complicated as knowing where to invest. ...
  3. What is the difference between the Dow and the Nasdaq?

    Because of the way people throw around the words "Dow" and "Nasdaq," both terms have become synonymous with "the market," ...
  4. Which day is known as China's "Black Tuesday" and why?

    On February 27, 2007, the Chinese stock market suffered a correction, causing choppy markets all over the world. The Shanghai ...
RELATED TERMS
  1. Comprehensive Automated Risk Data System (CARDS)

    The Comprehensive Automated Risk Data System (CARDS) is an initiative ...
  2. Baked In The Cake

    Projections, expectations and other news items that are already ...
  3. Hospital Visitation Authorization

    A document that indicates who is allowed to visit a patient in ...
  4. Restricted Stock

    Insider holdings that are under some other kind of sales restriction. ...
  5. Sick Industrial Companies Act (SICA)

    A key piece of legislation dealing with the issue of rampant ...
  6. Red Herring

    A preliminary prospectus filed by a company with the Securities ...
comments powered by Disqus
Related Articles
  1. Material Adverse Effect A Warning Sign ...
    Markets

    Material Adverse Effect A Warning Sign ...

  2. Changes In Tax Legislation And Regulation
    Taxes

    Changes In Tax Legislation And Regulation

  3. SEC Filings: Forms You Need To Know
    Investing Basics

    SEC Filings: Forms You Need To Know

  4. Footnotes: Early Warning Signs For Investors
    Retirement

    Footnotes: Early Warning Signs For Investors

  5. How To Become A Corporate Board Member ...
    Personal Finance

    How To Become A Corporate Board Member ...

Trading Center