Originally Posted by
JohnF
Two things:
1) It's an index, based to a set point in time, and the difference between 100 (the base time period) and the current value of the index is the cumulative change in the values of the stocks thus included. Since it is based on 100 stocks chosen by the Financial Times from the London Stock Exchange (hence FTSE, Financial Times Stock Exchange or "Footsie"), based on their market capitalization to reflect the top 100 stocks exchanged on that market, the content of that index changes over time as companies grow and decline over time.
2) It is used as one of the premier benchmarks for return on equity when buying stocks. If the stocks you are buying outperform the FTSE 100, then you've purchased stocks that have outperformed, in terms of return on equity, the top 100 stocks of the LSE. As a result, it is one of the premier benchmarks for the UK when making the decision which kind of mutual fund, for instance, to purchase as an speculative purchase.
Now, that said, you purchase stocks for two reasons: the first speculative, the second dividends. While the latter has largely fallen out of favor for those with money (as it is a decision by the company that you as an investor cannot usually influence and many running companies are relatively loathe to disburse profits instead of reinvesting them), it has started to make a bit of a comeback for those choosing stocks for their dividend payments as part of their portfolio purchases. However, most people buy stock because of the relatively large short-term speculative gains that can be realized, as well as long-term appreciation of capital.
The importance of a stock price, which, summed and weighted, represents the FTSE 100, is the implicit desirability of that stock for the stock-purchasing investor. While value investing (buying stock of companies based on their long-term economic value, rather than on dividends or expected short-term speculative gains) has also fallen out of favor (largely because it is hard to get a feel which companies will provide this), it is where serious fortunes are made (and some lost).
Finally, stock prices reflect the discounted expectations of future profitability for those companies. Given that GDP, on the income side, is made up of corporate profits and real personal disposable income, an increase in a stock price indicates that investors expect those companies to increase their relative importance in overall economic development. If I think that company X is going to increase their profits well beyond their competitors (such as Apple, for instance), then demand for that company's stocks will increase, and, given the limited number of shares available, the price of that stock will increase.
That said, automated trading, high frequency trading, as well as demand driven by portfolio requirements, all deviate from these fundamentals. The way the market looks today has, more often than not, nothing to do with fundamentals, but rather is driven by too much money chasing the chimera of high levels of returns without risk (there is no such thing in the real world), leading to a highly speculative, highly chaotic and at times rather irrational (i.e. not reflecting stock fundamentals) pricing of equities on markets. This is not a good thing.
:-)