What is a Market Index?
A lot of investing-related language can be straight-up confusing. This can make ownership seem scary and much more complex than it actually is. We’d rather ownership be approachable, so we’re breaking down some of the common terms you might see or hear.
Ever heard of the S&P 500? How about the Dow? (They’re in the news quite a bit.) Both are market indices and are used to help describe the state of the stock market. Understanding what market indices are can help you make more sense of the news and daily movements of the stock market.
What is a market index?
A market index is a group of stocks that are used as representatives of how certain parts of the stock market are performing. When you see them in the news or in stock ticker apps, you’ll usually see the index’s trading symbol alongside the value of the index, and an arrow up or down with how many percentage points it is in a direction.
So, that series of numbers and letters may look pretty complicated. But here’s what all that means:
Value: The value of an index is shown as a number, similar to a stock price but not quite. Unlike a stock price, an index’s value isn’t described in dollars, but in points. Don’t worry too much about what a “point” is worth—it’s just a quantifiable representation of the index as a whole.
Percentage point: The percentage the value of the index has changed since the last market close.
Arrow: The direction the value has moved since the last market close (the end of the last stock market business day). An arrow up indicates the index’s value has grown. A down arrow means it’s dropped in value.
Now that we have a general understanding of market indices in general, let’s walk through the three most talked-about indexes in the U.S.
The Dow, aka the Dow Jones Industrial Average, aka DJIA
The Dow is in the news all the time. Definitely one of the most well-known market indices, it’s also the oldest in the U.S., originally founded as the Dow Jones Average in 1885 (it became the Dow Jones Industrial Average in 1896).
But what is the Dow? It’s a “broad-based index,” which means it’s intended to capture the performance of the stock market as a whole. That said, it only includes 30 different stocks from fairly large corporations across a variety of industries, not just traditional heavy industry as the name would have you believe. “Industrial” is mostly a nod to the past at this point.
The value of the Dow is calculated differently than some newer indices. It’s "price-weighted," which means the value is calculated by adding up the prices of all of the stocks included, then dividing by the number of stocks. Sort of like what you used to do in middle school math, but a little more complicated nowadays thanks to corporate actions like stock splits and spin-offs—topics for another time.
Something to keep in mind when you’re hearing about the Dow: it’s not an end-all-be-all gauge of how the economy is performing. A change in the Dow could represent changes in how owners of those stocks are feeling about the companies included and their expectations of potential earnings. Plus, because the general attitude about really large companies is typically different than other companies in the market, it’s not necessarily even the best gauge of all industries or the stock market in general.
The S&P 500, aka the Standard & Poor’s 500
Founded in 1957, the S&P 500 includes 500 (bet you couldn’t have guessed that) of the most widely-traded stocks in the U.S. across a variety of sectors, including healthcare, tech, energy, consumer staples, and so on.
It’s considered a better gauge of the stock market than the Dow because it’s more diverse and it’s what’s called a "float-adjusted market-cap index." At a super high-level, that just means that the largest companies typically have the most influence on the S&P 500’s value.
If you’re curious, here’s a bit of the nitty-gritty: the value is based on "market capitalization," which is a company’s stock price multiplied by the number of outstanding shares. As you might guess, larger companies will likely have a larger market capitalization. The S&P 500 then takes a weighted average of all of the included companies’ market capitalizations, meaning that the larger ones have more influence on the value of the index.
The NASDAQ Composite Index, aka NASDAQ
Often just described as “NASDAQ,” the NASDAQ Composite index is not the same thing as the stock exchange. But it is, however, a market-capitalization index of all NASDAQ-listed stocks, which are largely in the tech industry.
Some things to keep in mind: the NASDAQ includes some non-U.S. companies, as well as companies of all sizes. Because of that, any change in the value usually reflects how investors are feeling about the tech industry in general.