What are the 3 Major Stock Indexes?

Stock Index Overview

First off, an index is a method to organize and track the performance of a group of assets in a standardized way. Indexes typically measure the performance of a basket of securities intended to replicate a certain area of the market. The performance of a market index provides a quick way to see the health of certain areas of the market.

Stock market indexes around the world are powerful indicators for global and country-specific economies. In the United States the S&P 500, Dow Jones Industrial Average, and Nasdaq Composite are the three most broadly followed indexes by both the media and investors. In addition to these three indexes, there are approximately 5,000 others that make up the U.S. equity market.

Indexes can be constructed as broad-based and capture the entire market, such as the S&P 500 or the Dow Jones. Indexes can be more specialized and track a particular industry or segment such as the Russell 2000, which tracks only small-cap stocks, or the Nasdaq, which tracks the large-cap technology industry.

Stock Index Details

Each stock market index uses its own proprietary formula when determining which companies to include. Indexes that measure the performance of broad swathes of the market may only include companies that rank highly in terms of market capitalization, or the total value of all of their outstanding shares. Alternatively, they may be selected by an expert committee or simply represent all of the shares that trade on a certain stock exchange.

Once an index manager has determined which companies to include, they then need to determine how those companies are represented in the index, a factor called index weighting. Depending on weighting, all companies included in an index can have an equal impact on index performance or a different impact based on market capitalization or share value.

The three most common index weighting models are:

  • Market-Cap Weighted: In a market cap-weighted index, the index more heavily represents stocks with higher market caps. With this structure, large companies have a bigger impact on the index’s performance.

  • Equal Weighted: With an equal-weighted index, the index treats all components the same. This means each company’s performance affects the index the same amount, whether they’re incredibly large companies or incredibly small.

  • Price Weighted: A price-weighted index grants each company a different weight based on its current share price. Companies with larger share prices have more clout in these indexes, regardless of how big or small the companies actually are.

Examples of Stock Indexes

The S&P 500 Index
One of the most well-known indexes, the S&P 500 tracks the performance of 500 top companies in the U.S., as determined by a committee at S&P Dow Jones Indices. The S&P 500 is a market-capitalization-weighted index. The S&P 500 Index represents approximately 80% of the total value of the U.S. stock market. In general, the S&P 500 Index gives a good indication of movement in the U.S. market as a whole.

The Dow Jones Industrial Average
The DJIA is relatively narrow in scope, tracking the performance of just 30 U.S. companies as selected by S&P Dow Jones Indices. The stocks within the DJIA come from a range of industries, from healthcare to technology, but are united by all being blue chip stocks. This means they have a history of strong financial performance. The DJIA is one of the few price-weighted market indexes.

The Nasdaq
The Nasdaq tracks the performance of 100 of the largest and most actively traded stocks listed on the Nasdaq stock exchange. Companies within the Nasdaq can be in many different industries, but they generally veer toward technology and don’t include any members of the financial sector. The Nasdaq 100 uses a market-cap weighting.

Conclusion on Stock Indexes

Indexes play an important part in the overall analysis of the U.S. equity market. Indexes and their movements provide a great deal of insight into the economy, the investing public’s risk appetite, and the trends for investing diversification. In general, understanding the nuances of their construction and composition can be essential for making all types of investment decisions.

Happy Trading, Verdia

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Charles E Winchester