Understanding Stock Market Indexes: S&P 500, Dow Jones, and Nasdaq

August 18, 2023

Even if you know nothing about investing, you have probably heard once or twice such things as «S&P 500 is down six points». So now we will find out who this mysterious S&P 500 is and why investors need it, as well as other indices, so much. 

What are stock market indexes and why are they crucial

Stock market indexes, or simply indexes are statistical measures that track the performance of a specific group of stocks or securities in the stock market. They provide a snapshot of how a particular market segment is performing over time. 

Indexes are crucial for several reasons:

  • Providing a benchmark for performance. They provide a benchmark against which to measure the performance of individual stocks, investment funds, and other investments. It can be helpful for investors to track their progress and make sure that they are making sound investment decisions.
  • Diversifying portfolios. Indexes help investors diversify their portfolios by allowing them to invest in a broad representation of stocks within a specific market segment. Instead of buying individual stocks, investors can invest in index funds or exchange-traded funds (ETFs) that mirror the performance of an index. 
  • Easy tracking. Stock market indexes are easy to track and understand. It makes them a good choice for investors who are new to the stock market or who do not have time to research individual stocks.

Commonly known indexes include the S&P 500, Dow Jones Industrial Average (DJIA), Nasdaq Composite, and Russell 2000. These indexes track various groups of stocks, such as large-cap, tech-focused, or small-cap companies.

Standard and Poor’s 500 (S&P 500) index

The Standard & Poor's 500 Index, or S&P 500, is one of the most widely followed and recognized stock market indexes. It represents a broad and diverse cross-section of the U.S. stock market and is often used as a benchmark for the overall performance of the U.S. equities market. The S&P500 is designed to be a market-cap-weighted index, which means that the weight of each stock in the index is determined by its market capitalization. That is, the largest companies in the index have the most influence on their performance.

The S&P 500 is rebalanced quarterly, which means that stocks are added and removed from the index based on their market capitalization. To be included in the S&P 500, a company must meet certain criteria, such as having a market capitalization of at least US$14.5 billion and a minimum monthly trading volume of 250,000 shares.

The SP500 is a popular benchmark for performance. Investors use it to track the performance of the stock market as a whole and to compare the performance of different investment strategies. It is also used to create index funds, which are investment funds that track the index’s performance.

Dow Jones Industrial Average (DJIA)

The Dow Jones Index is one of the oldest and most well-known stock market indexes in the world. 

The DJIA consists of 30 blue-chip companies that are leaders in their respective industries. The selection of these companies is not based solely on quantitative factors like market capitalization. Instead, the index committee at S&P Dow Jones Indices, the organization that oversees the index, considers factors like the company's reputation, industry leadership, and relevance to the U.S. economy.

Like the S&P 500, the Dow Jones is also rebalanced quarterly. To be included in the DJIA, a company must meet certain criteria, such as having a market capitalization of at least US$8.2 billion and a minimum daily trading volume of 2 million shares.

Many investors use the Dow as a benchmark to compare the performance of their portfolios. It is often seen as a measure of how well the overall market is doing, especially in the context of large, established companies.

Nasdaq Composite Index

The Nasdaq Composite Index, or simply Nasdaq, is a stock market index that tracks the performance of a wide range of publicly traded companies listed on the Nasdaq Stock Market. It is one of the most widely followed stock market indices in the world and is known for its heavy emphasis on technology and internet-related companies. The Nasdaq Composite Index includes companies from various sectors, but it has a significant representation of technology, internet, and biotechnology firms.

The Nasdaq is known for its heavy weighting of technology companies, especially those involved in hardware, software, telecommunications, and internet-related services. Companies like Apple, Microsoft, Amazon, Google (Alphabet), and Facebook (Meta Platforms) often have a significant impact on the index's movements.

Investors can invest in the Nasdaq Composite Index through various financial instruments, such as exchange-traded funds (ETFs) and mutual funds that track their performance. These investment vehicles allow individuals and institutional investors to gain exposure to a diversified portfolio of companies represented in the index.

Overall, stock market indexes are a valuable tool for investors. They provide a way to measure the performance of the stock market as a whole and to compare the performance of different markets or sectors.