An Introduction to Stock Market Indexes
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An Introduction To Stock Market Indexes
By Kate Schick
You may also like: Does Warren Buffett own the same stock as you?
It's not unusual for people to talk about "the market" as if there were a common
meaning for the word. But in reality, the many indexes of the differing segments
of the market don't always move in tandem. If they did, there would be no reason
to have multiple indexes. By gaining a clear understanding of how indexes are
created and how they differ, you will be on your way to making sense of the daily
movements in the marketplace. Here we'll compare and contrast the main
market indexes so that the next time you hear someone refer to "the market",
you'll have a better idea of just what they mean.
The Dow
The Dow Jones Industrial Average (DJIA) is one of the oldest, most well-known
and most frequently used indexes in the world. It includes the stocks of 30 of the
largest and most influential companies in United States. The DJIA is what's
known as a price weighted index. It was originally computed by adding up the
per-share price of the stocks of each company in the index and dividing this sum
by the number of companies - that's why it's called an average. Unfortunately, it
is no longer this simple to calculate. Over the years, stock splits, spin-offs and
other events have resulted in changes in the divisor, making it a very small
number (less than 0.2).
The DJIA represents about a quarter of the value of the entire U.S. stock market,
but a percent change in the Dow should not be interpreted as a definite
indication that the entire market has dropped by the same percent. This is
because of the Dow's price-weighted function. The basic problem is that a $1
change in the price of a $120 stock in the index will have the same effect on the
DJIA as a $1 change in the price of a $20 stock, even though one stock may have
changed by 0.8% and the other by 5%.
A change in the Dow represents changes in investors' expectations of the
earnings and risks of the large companies included in the average. Because the
general attitude toward large-cap stocks often differs from the attitude toward
small-cap stocks, international stocks or technology stocks, the Dow should not
be used to represent sentiment in other areas of the marketplace. On the other
hand, because the Dow is made up of some of the most well-known companies in
the U.S., large swings in this index generally correspond to the movement of the
Marketplace
AAA |
entire market, although not necessarily on the same scale.
The S&P 500
The Standard & Poor's 500 Stock Index is a larger and more diverse index than
the DJIA. Made up of 500 of the most widely traded stocks in the U.S., it
represents about 70% of the total value of U.S. stock markets. In general, the S&P
500 index gives a good indication of movement in the U.S. marketplace as a
whole.
Because the S&P 500 index is market
weighted (also referred to as
capitalization weighted), every stock
in the index is represented in
proportion to its total market
capitalization. In other words, if the
total market value of all 500
companies in the S&P 500 drops by
10%, the value of the index also
drops by 10%. A 10% movement in
all stocks in the DJIA, by contrast,
would not necessarily cause a 10% change in the index. Many people consider
the market weighting used in the S&P 500 to be a better measure of the market's
movement because two portfolios can be more easily compared when changes
are measured in percentages rather than dollar amounts.
The S&P 500 index includes companies in a variety of sectors, including energy,
industrials, information technology, healthcare, financials and consumer staples.
The Wilshire 5000
The Wilshire 5000 is sometimes called the "total stock market index" or "total
market index" because almost all publicly-traded companies with headquarters
in the U.S. that have readily available price data are included in the Wilshire
5000. Finalized in 1974, this index is extremely diverse, including stocks from
every industry. Although it's a near-perfect measure of the entire U.S. market,
the Wilshire 5000 is referred to less often than the less comprehensive S&P 500
when people talk about the entire market.
The Nasdaq Composite Index
Most investors know that the Nasdaq is the exchange on which technology stocks
are traded. The Nasdaq Composite Index is a market-capitalization-weighted
index of all stocks traded on the Nasdaq stock exchange. This index includes
some companies that are not based in the U.S. Although this index is known for
its large portion of technology stocks, the Nasdaq Composite also includes stocks
from financial, industrial, insurance and transportation industries, among others.
The Nasdaq Composite includes large and small firms but, unlike the Dow and
the S&P 500, it also includes many speculative companies with small market
capitalizations. Consequently, its movement generally indicates the performance
of the technology industry as well as investors' attitudes toward more speculative
stocks.
The Russell 2000
The Russell 2000 is a market-capitalization-weighted index of the 2,000 smallest
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stocks in the Russell 3000, an index of the 3,000 largest publicly-traded
companies, based on market cap, in the U.S. stock market. The Russell 2000
index gained popularity during the 1990s, when small-cap stocks soared and
investors moved more money to the sector. The Russell 2000 is the best-known
indicator of the daily performance of small companies in the market; it is not
dominated by a single industry.
The Bottom Line
It's good to know what's going on in the many diverse segments of the U.S. and
international markets. If you're going to pick just one index, or market, to talk
about, however, you can't go wrong with the S&P 500, which offers a good
indication of the movements in the U.S. market in general. By watching indexes
and keeping track of their movements over time, you can get a good handle on
the investing public's general attitude toward companies of all different sizes and
from varying industries.
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DICTIONARY
INVESTING
MARKETS
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Investing Basics Bonds & Fixed Income
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EXAM PREP
Symbol
TUTORIALS
VIDEO
SIMULATOR
Economics Calculators Tutorials
An Introduction To Stock Market Indexes
By Kate Schick
You may also like: Does Warren Buffett own the same stock as you?
It's not unusual for people to talk about "the market" as if there were a common
meaning for the word. But in reality, the many indexes of the differing segments
of the market don't always move in tandem. If they did, there would be no reason
to have multiple indexes. By gaining a clear understanding of how indexes are
created and how they differ, you will be on your way to making sense of the daily
movements in the marketplace. Here we'll compare and contrast the main
market indexes so that the next time you hear someone refer to "the market",
you'll have a better idea of just what they mean.
The Dow
The Dow Jones Industrial Average (DJIA) is one of the oldest, most well-known
and most frequently used indexes in the world. It includes the stocks of 30 of the
largest and most influential companies in United States. The DJIA is what's
known as a price weighted index. It was originally computed by adding up the
per-share price of the stocks of each company in the index and dividing this sum
by the number of companies - that's why it's called an average. Unfortunately, it
is no longer this simple to calculate. Over the years, stock splits, spin-offs and
other events have resulted in changes in the divisor, making it a very small
number (less than 0.2).
The DJIA represents about a quarter of the value of the entire U.S. stock market,
but a percent change in the Dow should not be interpreted as a definite
indication that the entire market has dropped by the same percent. This is
because of the Dow's price-weighted function. The basic problem is that a $1
change in the price of a $120 stock in the index will have the same effect on the
DJIA as a $1 change in the price of a $20 stock, even though one stock may have
changed by 0.8% and the other by 5%.
A change in the Dow represents changes in investors' expectations of the
earnings and risks of the large companies included in the average. Because the
general attitude toward large-cap stocks often differs from the attitude toward
small-cap stocks, international stocks or technology stocks, the Dow should not
be used to represent sentiment in other areas of the marketplace. On the other
hand, because the Dow is made up of some of the most well-known companies in
the U.S., large swings in this index generally correspond to the movement of the
Marketplace
AAA |
entire market, although not necessarily on the same scale.
The S&P 500
The Standard & Poor's 500 Stock Index is a larger and more diverse index than
the DJIA. Made up of 500 of the most widely traded stocks in the U.S., it
represents about 70% of the total value of U.S. stock markets. In general, the S&P
500 index gives a good indication of movement in the U.S. marketplace as a
whole.
Because the S&P 500 index is market
weighted (also referred to as
capitalization weighted), every stock
in the index is represented in
proportion to its total market
capitalization. In other words, if the
total market value of all 500
companies in the S&P 500 drops by
10%, the value of the index also
drops by 10%. A 10% movement in
all stocks in the DJIA, by contrast,
would not necessarily cause a 10% change in the index. Many people consider
the market weighting used in the S&P 500 to be a better measure of the market's
movement because two portfolios can be more easily compared when changes
are measured in percentages rather than dollar amounts.
The S&P 500 index includes companies in a variety of sectors, including energy,
industrials, information technology, healthcare, financials and consumer staples.
The Wilshire 5000
The Wilshire 5000 is sometimes called the "total stock market index" or "total
market index" because almost all publicly-traded companies with headquarters
in the U.S. that have readily available price data are included in the Wilshire
5000. Finalized in 1974, this index is extremely diverse, including stocks from
every industry. Although it's a near-perfect measure of the entire U.S. market,
the Wilshire 5000 is referred to less often than the less comprehensive S&P 500
when people talk about the entire market.
The Nasdaq Composite Index
Most investors know that the Nasdaq is the exchange on which technology stocks
are traded. The Nasdaq Composite Index is a market-capitalization-weighted
index of all stocks traded on the Nasdaq stock exchange. This index includes
some companies that are not based in the U.S. Although this index is known for
its large portion of technology stocks, the Nasdaq Composite also includes stocks
from financial, industrial, insurance and transportation industries, among others.
The Nasdaq Composite includes large and small firms but, unlike the Dow and
the S&P 500, it also includes many speculative companies with small market
capitalizations. Consequently, its movement generally indicates the performance
of the technology industry as well as investors' attitudes toward more speculative
stocks.
The Russell 2000
The Russell 2000 is a market-capitalization-weighted index of the 2,000 smallest
Trading Center
Subscribe to our Free Newsletters!
Enter e-mail address
Sign Up
Learn More »
stocks in the Russell 3000, an index of the 3,000 largest publicly-traded
companies, based on market cap, in the U.S. stock market. The Russell 2000
index gained popularity during the 1990s, when small-cap stocks soared and
investors moved more money to the sector. The Russell 2000 is the best-known
indicator of the daily performance of small companies in the market; it is not
dominated by a single industry.
The Bottom Line
It's good to know what's going on in the many diverse segments of the U.S. and
international markets. If you're going to pick just one index, or market, to talk
about, however, you can't go wrong with the S&P 500, which offers a good
indication of the movements in the U.S. market in general. By watching indexes
and keeping track of their movements over time, you can get a good handle on
the investing public's general attitude toward companies of all different sizes and
from varying industries.
Get Out of Debt – Start Making Money
Want to get out of debt, get a mortgage and save for retirement? Investopedia’s
FREE Personal Finance newsletter shows you 7 Steps to Become Financially
Independent. Take control of your money and Click here to start managing your
finances like the pros.
TAGS:
Capital Market
Russell Indexes
Dow Jones Industrial Average
Index Funds
NASDAQ Composite
S&P 500
Ads
Buy & Trade Stocks Online
www.ufx.com/Stocks-Trading
1. Sign Up 2. Deposit 3. Trade Trade Securely at UFX.com Today!
China Solar Panel
made-in-china.com
Find Audited China Manufacturers Of Solar Panel. Order Now!
Free stock market data
www.advfn.com
Get the latest stock market prices free inc charts and latest news
License Content Order Reprints
YOU MAY ALSO LIKE
6 Worst Financial
Mistakes You Could
Possibly Make
15 High Paying Hourly
Jobs
How The World's
Billionaires Stay Safe
In Davos
10 Good Reasons to
Quit Your Job Right
Now
What Do CEOs Actually
Do?
What It Takes To
Become An Elite
The 12 Highest Paying
Jobs in 2014
5 Bad Money Habits
You Need to Quit
Trader
TOP
Search Investopedia
DICTIONARY: #
A
B
C
D
E
F
G
H
I
J
K
L
M
N
O
P
CONTENT LIBRARY
Articles
Terms
R
S
T
U
V
W
X
Y
CONNECT WITH INVESTOPEDIA
Videos
Free Annual Reports
Tutorials
Slideshows
Stock Simulator
FXtrader
FAQs
Calculators
Exam Prep Quizzer
Chart Advisor
Stock Analysis
Net Worth Calculator
WORK WITH INVESTOPEDIA
License Content
Q
Symbol
Advertise With Us
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© 2015, Investopedia, LLC. All Rights Reserved Terms Of Use Privacy Policy
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