In-depth analysis of the Taiwan stock market index: from fundamentals to practical applications

In the Taiwanese stock market investment realm, the Taiwan Stock Market Index is the most commonly referenced barometer by investors. Whether retail or institutional investors, they all use this indicator to grasp the overall market trend. However, many people’s understanding of the Taiwan Stock Market Index may still be at the superficial level of “it went down” or “it went up,” with little knowledge of its underlying calculation logic, application methods, and investment limitations.

The True Face of the Taiwan Weighted Index

The Taiwan Stock Exchange’s Taiwan Weighted Index is the primary indicator reflecting the overall performance of Taiwan’s stock market, including all common stocks listed on the exchange. When news reports say “how the Taiwan stock market is performing,” they are actually referring to the changes in this index’s points.

To understand why an index can represent the entire stock market, one must first understand what a weighted average is. Imagine a school with two classes: Class 1 has 10 students with an average score of 80, and Class 2 has 20 students with an average score of 90. How should the overall school average be calculated? Considering the number of students, it should be (1/3×80) + (2/3×90) = 86.7 points. This is the concept of weighting—assigning different data points different proportions of influence.

Price-Weighted vs Market Cap-Weighted: Two Methods of Index Calculation

Global stock markets mainly adopt two types of weighting methods. Among them, the Dow Jones Industrial Average uses a price-weighted method, summing the prices of selected stocks on a base date to form the base value. For example, if the market has Stock A at 450 yuan and Stock B at 550 yuan on the base date, the total price is 1000 yuan, and the index is 100 points. The next day, if Stock A rises to 550 yuan and Stock B to 600 yuan, the total price becomes 1150 yuan, and the index rises to 115 points.

This method has a clear flaw—high-priced stocks overly influence the index, while fluctuations in low-priced stocks are easily overlooked. A significant rise or fall in one stock might dominate the index’s movement, failing to truly reflect broad market changes.

In contrast, the Taiwan Weighted Index and the US S&P 500 use a market cap-weighted method, where the market value of listed companies serves as the basis for weighting. Market cap = stock price × number of shares issued, which better reflects a company’s actual market influence. For example, Company A’s stock price is 150 yuan/share with 2,000 shares issued, giving a market cap of 300,000 yuan; Company B’s stock price is 5 yuan/share with 140,000 shares issued, with a market cap of 700,000 yuan. The combined market cap is 1 million yuan, and the index is 100 points. If after one month, Company A’s stock drops to 130 yuan (market cap 260,000 yuan) and Company B’s rises to 10 yuan (market cap 1,400,000 yuan), the total market cap becomes 1,660,000 yuan, and the index rises to 166 points.

The Reality of Investing in the Market Index: Advantages and Limitations

Advantages of Using Market Indices

Market cap-weighted indices cover all listed stocks, making their sampling scope the most comprehensive, capable of reflecting the overall market trend and stage to the greatest extent. Compared to tracking individual stocks, focusing on the market index provides a more macro perspective.

Five Major Limitations of Using Market Indices

1. Over-dominance of Leading Companies

Because of the market cap weighting, high-market-cap companies’ gains or losses greatly influence the index. In Taiwan, TSMC’s weight is particularly heavy, and its performance can overshadow the true condition of hundreds of small and medium-sized enterprises, leading to contradictory phenomena like “index rising but individual stocks falling” or “index falling but individual stocks rising.”

2. Inability to Capture Stock-Specific Differences

The market index only reflects an average level, but individual stocks can vary greatly. Some industries or stocks may perform well despite a declining overall market, or be relatively weak during an uptrend. Relying solely on the index for decision-making can lead to errors.

3. Industry Concentration Risk

Electronics stocks hold a large weight in Taiwan’s market, so the index’s fluctuations are often dominated by this industry, neglecting opportunities in other sectors. When the tech industry faces adjustments, the index’s decline may far exceed the actual situation of other industries.

4. Amplification of Market Sentiment

Speculative trading, sudden news events, or political factors often cause overreactions in the market. These emotional swings are amplified in the index, causing divergence from fundamental conditions.

5. Limited Coverage

The index only includes listed companies, ignoring smaller, less traded, or unlisted firms, thus failing to fully reflect Taiwan’s overall economic situation.

6. Time Lag

Indices are updated periodically, but markets change rapidly. Relying on the index in fast-moving situations can create a time lag. Overdependence on a single index may cause investors to miss the pace of different sectors’ rises and falls, leading to missed opportunities at various stages.

Using Technical Analysis Rationally to View Market Trends

Technical analysis is based on historical price movements to forecast future trends. While it cannot predict the market with certainty, it helps investors increase the probability of success.

Analytical Framework: From Macro to Micro

Professional analysts often adopt a “top-down” approach:

• First Step: Macro Market Analysis — Use major indices (S&P 500, Dow Jones Industrial Average, etc.) to judge the overall direction of global and Taiwan markets.
• Second Step: Industry Comparison Analysis — Identify currently strong and weak industries.
• Third Step: Deep Dive into Individual Stocks — Select specific targets within the chosen industries.

Core Technical Indicators

Grasping Trend Direction

Observe trend lines or moving averages. When prices stay above an upward-sloping trend line, with higher lows and higher highs, the trend is upward. Conversely, the opposite indicates a downward trend.

Identifying Support Levels

Support levels are prices where buyers are willing to enter, often causing the price to rebound after falling to this point. If the price breaks below support, it suggests further decline and weakening buying strength.

Identifying Resistance Levels

Opposite to support, resistance levels are prices where the stock tends to stall or reverse downward, usually near previous highs. Breaking through resistance signals a bullish trend.

Candlestick Pattern Analysis

Candlesticks show opening, closing, highest, and lowest prices. The highest point during the session reflects buying strength; the lowest reflects selling strength; the closing price is the final balance point. By analyzing candlestick patterns, traders can see how supply and demand battles unfold and conclude. When a strong buy pushes the price to the daily high, followed by selling pressure bringing the close lower, it indicates sellers have the upper hand. However, if the closing price remains above the opening price despite selling pressure, it shows buyers retreated but did not fully give up.

Special Situations: Impact of Extreme News

When extreme news like a CEO’s sudden death or terrorist events shocks the market, technical analysis may become invalid. Investors need patience until market sentiment stabilizes before conducting effective analysis.

Practical Investment Methods and Precautions for Taiwan Stock Market Index

Three Investment Approaches

Via ETF Funds

The most common method is purchasing ETFs that track the market index. These passive funds are managed to mirror the index, resulting in low costs, relatively stable returns, but limited upside potential. Suitable for investors seeking risk diversification.

Stock Index Futures and Options

Advanced investors can use Taiwan stock index futures and options for arbitrage or hedging, but require higher professional knowledge and risk management skills.

Five Essential Precautions Before Investing

Assess Personal Risk Tolerance

All financial products carry risks. Investors must honestly evaluate their risk preferences and decide on investment scale accordingly. Do not gamble everything.

Understand Component Stock Weights Deeply

High market cap companies have greater influence on the index. TSMC’s weight in Taiwan stocks is especially high, and its stock fluctuations significantly impact the overall index. Investors should pay close attention to these leading stocks.

Master Trading Hours and Time Differences

The Taiwan Stock Exchange operates from Monday to Friday, 9:00 AM to 1:30 PM (GMT+8). Overseas investors should be aware of time differences to avoid missing trading opportunities.

Continuously Monitor Macro Economic Indicators

Taiwan’s GDP growth rate, central bank interest rate policies, inflation rate, and global economic conditions all influence the stock market. Investors should regularly review these macro data.

Combine Multiple Indicators for Decision-Making

The market index is only a reference tool and should not be the sole basis for decisions. Combining technical indicators, fundamental analysis, and industry trends provides a more rational investment approach.

Summary

The Taiwan Stock Market Index is an important window into Taiwan’s stock market, but it also has obvious limitations. If investors understand its calculation logic, master technical analysis methods, know the weight distribution, and combine other analytical tools carefully, they can seize opportunities while effectively managing risks. Remember: the index is a map, not a destination; it guides the direction but does not guarantee arrival.