Stock Market Tips: Introduction to the Nasdaq Biotechnology Index

The Nasdaq Biotechnology Index (NBI) is a measurement tool consisting of a compilation of companies that meet Nasdaq's 'eligibility criteria'. The index was introduced on November 1, 1993 and the businesses it is comprised of have been monitored over time as a performance metric for the biotechnology sector of the economy. As prices of each company's stock fluctuate a change is noted on the index. These changes are recorded daily and represented in the form of a graph. Every half year the companies are evaluated for compliance with listing criteria and each year companies may be removed or added from the index. As of July 2007, there are approximately 172 companies listed on the index.

How the Index Works:

The stocks represent a big pool of companies whose sizes are different. Since each company's size is different the affect it will have on the index should be proportionate. To make the index proportional, each stock's influence on the index metric is weighted according to its capitalization. The Nasdaq calls this "Modified Capitalization-weighted". The final computation results in a value that is based at a starting value.

The most important thing to know about this term is that it is a mathematically derived proportionality of each company's influence on the index based on the value of outstanding shares. If an index weights the companies in a portfolio using a weighted average it is providing a more accurate assessment of the index value.

The actual calculation may use what is called a 'weighted average'. A weighted average is a sophisticated calculation of average i.e. sum of variables divided by the number of parts weighted to account for specific differences in each variable. For example, suppose you have 100 apples and 60 apples weigh 50 grams and 40 apples weigh 40 grams. The weighted average takes into account the weight of each fruit and the number of that fruit. In this case, the average would assign value to the greatest amount of apples with the greatest amount of weight. Mathematically, 60% of the total weight would be attributed to the large apples and 40% of the total weight would be assigned to the smaller apples. Since the total weight is 4600 i.e 60 * 50=3000 + 40 * 40= 1600= 4600/100=46. I.E the weighted average of the weight of apples is 46 grams/apple.

Why the Index is Useful:

The Nasdaq Biotechnology Index is useful because it helps industry specialists, economists, investors and day traders measure the Biotechnology sector. The measurement or metric is important for the following reasons:

1-Provides insight into the health of the biotechnology industry.
2-Allows analysts to compare the performance of U.S. listed businesses with foreign companies.
3-Assists economists in decision making related to interest rates and economic performance.
4-Illustrates which companies are performing well enough to be listed on and remain on the index.

There are many more uses for an index but generally the index is a measurement tool used in assessing the Biotechnology and Bio-Pharmaceutical industry. Over time the value of the index changes indicating momentum, stagnation or decline in the financial performance of these companies. Additionally the NBI graphs and component values can be analyzed statistically for more accurate financial indicators, patterns and relationships.

Sources:

http://dynamic.nasdaq.com/reference/IndexDescriptions.stm
http://dynamic.nasdaq.com/dynamic/nasdaqbiotech_activity.stm
http://www.investorwords.com/2969/market_capitalization.html
http://en.wikipedia.org/wiki/Weighted_average