When people talk about how the market did on a given day, they probably
throw around terms like "The Dow" and "NASDAQ" and "S&P 500". These
are beautifully simple things that represent a fraction of the market as a
whole, but they're useful fibs on their own.
Each of these three represents a carefully chosen collection of public
companies. For example, the Dow Jones Industrial Average contains 30 American
companies such as Boeing, IBM, and Wal-Mart. The S&P 500 contains 500
very large American companies. The NASDAQ has over 3000 companies. The total
market of stocks you can buy and sell is much, much bigger than these three
indexes, but each index represents something unique.
What's a Stock Market Index?
Every stock market index has a specific goal. It may be to identify stocks
in a particular geographic reason (such as the Oregonian Index). It may be to group
stocks of a particular sector or business type (automotive stocks, financial
stocks). By grouping stocks together, it's possible to analyze broader trends
of businesses: the steel market is doing well this year, the eastern region of
Canada appears to be suffering an economic slow down, et cetera.
An index doesn't and cannot represent the entirety of the market (unless
it's a whole market index), but it can give you interesting information.
What is the Dow Jones Industrial Average?
The Dow Jones Industrial Average (or just "the Dow") is an index of 30 of
the largest public companies in American business. Unlike many other indexes,
the single number that goes up or down every day is price-weighted
index, where the price of every individual stock (in isolation of
other factors) affects the daily fluctuation of the stocks. Thus if the prices
of some member stocks go up more than the prices of other member stocks go
down, the Dow value goes up. Easy, right?
The Dow applies a formula to attempt to guide the index to a historical
norm: for every dollar change to the price of a stock within the Dow, the Dow
moves by about 7.6 points. This multiplier can and will change.
The Dow has its flaws, in that it contains only 30 hand-selected
stocks—and those
stocks can change over time. It doesn't represent the overall market. It
also contains only the stocks of huge companies. Worse yet, it ignores the fact
that a $1 change in the price of a stock under $10 is more significant than a
$1 change in the price of a stock over $100. Yet it's still a popular measure
of market performance.
What is the S&P 500?
The S&P 500 index is a larger group of the stocks of 500 companies,
selected to represent the American economy in total. Unlike the price-weighted
dow, the S&P 500 reflects the amount of total money invested in
each stock. That is to say, a company with 10 public shares worth $10 each has
much less effect on the value of the index than a company with 100 public
shares worth $10 each.
The NASDAQ composite index contains stocks listed on the NASDAQ stock
exchange (similar to but different from the New York Stock Exchange). It's broader
than either of the other two mentioned indexes. It's relevant because the
NASDAQ exchange is even busier than the NYSE and it's the home to a
lot of technology stocks.
Where the DJIA tracks the largest American businesses and the S&P 500
tracks a broad section of big American businesses, the NASDAQ is a grabbag of
all sorts of market activity: big companies, small companies, up and comers, et
cetera. It's less predictable than the blue chips of the Dow or the reliable
bellwether S&P 500.
That unpredictability can make it more interesting, but "interesting" isn't
necessarily a prime goal in investing.
