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's the difference between the Dow Jones Industrial Average and the S&P 500?

    The DJIA is a price-weighted average of 30 stocks whereas the S&P 500 is a market value-weighted index of 500 stocks. Read Answer >>
  2. What is the difference between the Dow Jones Industrial Average and the S&P 500

    Learn about the Dow Jones Industrial Average and the S&P 500, including interesting facts about these indexes, and discover ... Read Answer >>
  3. Is the Dow Jones a public company?

    Find out how the Dow Jones Industrial Average tracks the health of the U.S. economy. This fluctuating number indicates the ... Read Answer >>
Related Articles
  1. Investing

    The Pros and Cons of Indexes

    Learn about the advantages and disadvantages of stock indexes and passive index funds. Discover how there is an opportunity cost to using index funds.
  2. Investing

    S&P 500 Vs. Dow Jones ETF: Which is a Safer Investment? (SPY,DIA)

    Learn about why the risks of investing in the ETFs that track the S&P 500 and the Dow Jones Industrial Average are very similar for investors.
  3. Investing

    The Hidden Flaws of Index Investing

    Index investing isn't always better than active investing. Here's why.
  4. Trading

    Using Index Futures To Predict The Future

    Want to know whether the stock market will open up or down? Check out the index futures.
  5. Investing

    What is an Index?

    An index is a statistical means of calculating a change in an economy or market.
  6. Investing

    Understanding And Playing The Dow Jones Industrial Average

    Learn strategies for investing in this price-weighted index and how to interpret its movements.
  7. Investing

    Understanding Capitalization-Weighted Indexes

    A capitalization-weighted index is a market index whose individual components are weighted according to their market capitalization.
RELATED TERMS
  1. Dow Jones Industrial Average - DJIA

    The Dow Jones Industrial Average is a price-weighted average ...
  2. Russell Small Cap Completeness Index

    A capitalization weighted index composed of all of the Russell ...
  3. Total Return Index

    A type of equity index that tracks both the capital gains of ...
  4. Market Index

    An aggregate value produced by combining several stocks or other ...
  5. Index Fund

    An index fund is a type of mutual fund with a portfolio constructed ...
  6. Composite

    A grouping of equities, indexes or other factors combined in ...
Trading Center