Must-read before investing in the Taiwan Stock Market Index: A comprehensive analysis of the Weighted Index operation mechanism and practical strategies

What exactly is the Taiwan Stock Market Index? Understand this basic concept first

If you often hear people talking about stock market trends, the term “Taiwan Stock Market Index” is definitely familiar. Simply put, the Taiwan Stock Market Index is the weighted stock price index of the Taiwan Stock Exchange, commonly known as the “weighted index” in the market.

The core function of this index is clear: it reflects the overall performance of all listed stocks traded on the Taiwan Stock Exchange, including large companies like TSMC and MediaTek. Investors can quickly grasp the overall trend of Taiwan’s stock market and economic conditions by observing the rise and fall of the index.

In daily life, when people mention “How many points did the Taiwan stock market go up today,” they are actually referring to changes in the index value. But to truly understand why an index can represent the entire stock market, you need to understand how the index is calculated.

How is the index calculated? Comparing two calculation methods

An index is essentially a weighted average. Using a class average score as an analogy: if one grade level has Class 1 (10 students, average 80 points) and Class 2 (20 students, average 90 points), the overall grade level average cannot simply be calculated as (80+90)÷2=85, because the number of students differs. The correct way is: Class 1 accounts for 1/3 of the population, Class 2 accounts for 2/3, so the overall average = 1/3×80 + 2/3×90 = 86.7 points. “Weighted” means assigning appropriate weights to each data point.

Globally, stock markets mainly use two methods to calculate weighted indices:

Method 1: Price-Weighted Index

A representative index is the Dow Jones Industrial Average. The calculation logic is: sum the prices of all sampled stocks on the base date, setting that as 100%.

Example: Suppose Stock A is 450 yuan and Stock B is 550 yuan on the base date, total 1000 yuan, and the index is set at 100 points. The next day, Stock A rises to 550 yuan, Stock B to 600 yuan, total 1150 yuan, so the index becomes 115 points (up 15 points).

The problem with this method is: stocks with higher prices have more influence, while lower-priced stocks are easily overlooked. A stock priced at 1000 yuan that moves 1% impacts the index more than a stock priced at 10 yuan that moves 50%.

Method 2: Market Cap-Weighted Index

This is the method used by the Taiwan Stock Market Index and the S&P 500, and it is the mainstream approach today. It uses the market capitalization of listed companies as weights, where market cap = stock price × number of shares outstanding.

Practical example: Company A has a stock price of 150 yuan/share, with 2000 shares issued, so market cap is 300,000 yuan; Company B has a stock price of 5 yuan/share, with 140,000 shares issued, so market cap is 700,000 yuan. The total market cap is 1 million yuan, and the index is set at 100 points.

One month later, Company A’s stock drops to 130 yuan/share, market cap becomes 260,000 yuan; Company B’s stock rises to 10 yuan/share, market cap becomes 1,400,000 yuan. The new total market cap is 1,660,000 yuan, and the index becomes 166 points (growth of 66 points). Market cap weighting avoids issues caused by price differences and better reflects actual market size changes.

Advantages and limitations of investing in the Taiwan Stock Market Index

Three advantages of investing via the index

First, a single index can grasp the overall market trend. The Taiwan Stock Market Index covers all common listed stocks, with comprehensive sampling, effectively reflecting the overall market movement.

Second, it is the best market thermometer for beginner investors. No need to analyze thousands of individual stocks; just look at one index to know whether Taiwan’s stock market is in a bull or bear phase.

Third, passive investment strategies based on the index have relatively controllable risks. Compared to active stock picking, ETFs tracking the index usually have lower fees and diversified risks.

But you also need to recognize its five major limitations

First trap: Big companies dominate

Because of market cap weighting, large companies have a huge influence on the index. In Taiwan, TSMC’s weight exceeds 10%, meaning its rise or fall greatly impacts the overall index. As a result, the movements of a few giants can completely overshadow the true condition of hundreds of small and medium enterprises.

Second trap: Can’t see individual stock differentiation

The index reflects an average level, but the market always has winners and losers. When the index declines, electronic stocks may all fall, but biotech stocks might rise against the trend; or vice versa. Focusing only on the index can cause you to miss structural opportunities.

Third trap: Industry weightings are overly concentrated

Taiwan’s stock market is heavily weighted toward a few industries like electronics and “national champions.” The index can be heavily influenced by fluctuations in these sectors. When global tech sentiment is poor, the entire market may be dragged down, hiding the true performance of other industries.

Fourth trap: Easily swayed by emotions

Foreign capital flows, political news, international events—non-fundamental factors—can cause market sentiment to fluctuate. These emotions are amplified in the index, potentially diverging from the stocks’ true value.

Fifth trap: Only includes listed companies

The index cannot reflect unlisted companies, small firms, or stocks with low trading volume. If you want to understand the real state of Taiwan’s economy, the index has obvious blind spots.

Conclusion: Don’t rely solely on the index as your decision-making standard. Combine it with individual stock analysis, industry research, and fundamental data to avoid being misled by the index.

Five steps to understand the index through technical analysis

Technical analysis is not about predicting stock prices but about finding patterns in historical price movements and assessing possible future directions. Note that technical analysis can improve win rates but cannot guarantee absolute predictions.

Step 1: Collect basic data

On any trading platform, you can obtain data such as opening price, closing price, highest, lowest, and volume for a stock or index over a specific period. Timeframes can be minutes (1 min, 5 min, 30 min), daily, weekly, or monthly, depending on your analysis purpose.

Step 2: Top-down multi-level analysis

Professional analysts often adopt a “pyramid” approach:

1. Start from macro-level, analyze major indices (e.g., S&P 500, Dow Jones, NASDAQ)
2. Then look at industry sectors, identify strong and weak sectors
3. Finally, focus on individual stocks’ specific performance

This approach helps confirm the overall trend before selecting stocks, avoiding counter-trend trades.

Step 3: Identify key trends

Use trend lines or moving averages to determine direction. As long as prices stay above upward-sloping trend lines or moving averages, an uptrend is in place; vice versa. Further, if each pullback forms a higher low and each rebound creates a higher high, it indicates a typical uptrend.

Step 4: Find support and resistance levels

• Support is a price zone where buyers find value, leading to buy orders. If the price breaks below support, it indicates buyer confidence is waning, and further decline may follow.
• Resistance (or pressure level) is a zone where sellers are willing to sell. When the price reaches resistance, it often stalls or pulls back. Breaking resistance is a bullish signal.

Step 5: Candlestick analysis—understanding buyer-seller battles

Candlesticks condense four data points—open, high, low, close—into a single K-line. Key points:

• Upper shadow indicates selling pressure
• Lower shadow indicates buying pressure
• The body (real body) shows the final consensus between buyers and sellers

For example, a bullish (positive) candle (close > open) with strong buying at the open, rising prices, but later some selling pushes the price back, yet the close remains above the open, indicating buyers ultimately won despite selling pressure. By observing candlestick patterns, you can gauge the strength of buying and selling forces during that period.

However, technical analysis has limitations: during “black swan” events (e.g., major negative news, political crises), technical signals may fail. In such cases, the wisest approach is to wait for the market to stabilize before re-analyzing.

Three main ways and precautions for investing in the Taiwan Stock Market Index

How to invest in the index? Comparing three methods

Method 1: ETF funds (best for retail investors)

Buying exchange-traded funds (ETFs) is the most common way. These are “passive funds” where fund managers do not actively select stocks but follow the index passively. Advantages are low costs and risk diversification; disadvantages are limited returns, but this suits most investors.

Method 2: Stock index futures (advanced investors)

Experienced investors can use Taiwan stock index futures for arbitrage or hedging. Risks and returns are higher.

Method 3: Options

Most complex, requiring in-depth understanding of derivatives strategies.

Five checklist items before starting to invest

Checklist 1: Assess your risk tolerance

All investments carry risks. Before investing, honestly evaluate how much loss you can tolerate. Choose investment methods aligned with your risk preference; avoid reckless bets.

Checklist 2: Understand component stock weights

TSMC accounts for over 10% of the index; other large stocks also hold 5-8%. This means a few stocks’ movements can drive the entire index. Be sure to understand this before investing.

Checklist 3: Know trading hours

Taiwan Stock Exchange trading hours are Monday to Friday, 9:00 AM to 1:30 PM (GMT+8). If you’re overseas, pay attention to time differences.

Checklist 4: Track macroeconomic data

Regularly monitor Taiwan and global economic indicators: GDP growth, interest rates, inflation, exchange rates. These directly influence stock market trends.

Checklist 5: Use multiple tools for decision-making

Don’t rely solely on the index. Combine technical analysis, fundamental research, and industry trends for more rational decisions.

Final advice

The Taiwan Stock Market Index is a powerful tool for understanding the market but not an all-in-one solution. It can tell you the overall market direction but not the true value of individual stocks. When using the index to gauge the market, always supplement with other technical indicators, fundamental analysis, and cautious decision-making to seize opportunities and trade wisely.