Now I will freely admit that for a long time, I was under the impression that the ALSi represented the average share price. So, for example, if I were told that the JSE-FTSE ALSi closed today at 34090, I would have said that meant “by the close of business today, an average share would have cost you R340.90. Because naturally, the ALSi would be quoted in cents”.
Now – why I thought that is anyone’s guess. But it makes no sense at all. I mean, for starters – why would the ALSi be quoted in cents? And the average share price is nonsensical.
So no. Not that then.
The question should be: what exactly is an index? Well, an index in any normal situation would have a base value set at some point in time, and then the index value subsequently would track the movement of the underlying relative to the original base value.
And this makes sense. A lot more sense than my initial assumption. Because – if I told you that the share price yesterday was R200, and the share price today is R250 – you would tell me that the share price increased by 25% ([250-200]/200). And then if the next day the share price drops back to R200 – you would tell me that the share price decreased by 20% ([250-200]/250). It all sounds a bit misleading, not so? An increase by 25%, a decrease by 20%, and we’re back to the same value?
Well the math is sound. But I would say that the human mind doesn’t like to work in percentages. The human mind likes to work in absolutes. So we determine a base value and track movement relative to that base value, more or less ignoring the percentage change.
So in the above example:
- Day 1 would be set as 100.
- Day 2 would be an increase to 125.
- Day 3 would be a decrease back down to 100.
There are some other issues at play here – do you include all securities in the index? What happens if some shares are bought back or more are issued – surely your base value then applies to a different universe of securities? Those issues are dealt with by methods of weighting the index and certain key assumptions.
But for most people, the key thing to realise is that these issues have been thought about and have been dealt with, and the index gives a numerical figure to the market movement today relative to the initial market value on the day that the index was first set.
I hope that makes sense.