Major Indices Explained

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    The Best Binary Options Broker 2020!
    Perfect For Beginners!
    Free Trading Education, Free Demo Account!
    Get Your Sing-Up Bonus Now!

  • Binomo
    Binomo

    Good Broker. Only For Experienced Traders!

An Introduction to U.S. Stock Market Indexes

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.

With so many indexes, the U.S. market has a wide range of methodologies and categorizations that can serve a broad range of purposes. The media most often reports on the direction of the top three indexes regularly throughout the day with key news items serving as contributors and detractors. Investment managers use indexes as benchmarks for performance reporting. Meanwhile, investors of all types use indexes as performance proxies and allocation guides. Indexes also form the basis for passive index investing often done primarily through exchange-traded funds that track indexes specifically.

Overall, an understanding of how market indexes are constructed and utilized can help to add meaning and clarity for a wide variety of investing avenues. Below we elaborate on the three most followed U.S. indexes, the Wilshire 5000 which includes all the stocks across the entire U.S. stock market, and a roundup of some of the other most notable indexes.

Key Takeaways

  • There are approximately 5,000 U.S. indexes.
  • The three most widely followed indexes in the U.S. are the S&P 500, Dow Jones Industrial Average, and Nasdaq Composite.
  • The Wilshire 5000 includes all the stocks from the U.S. stock market.
  • Indexes can be constructed in a wide variety of ways but they are commonly identified generally by capitalization and sector segregation.

Index

The S&P 500

The Standard & Poor’s 500 Index (known commonly as the S&P 500) is an index with 500 of the top companies in the U.S. Stocks are chosen for the index primarily by capitalization but the constituent committee also considers other factors including liquidity, public float, sector classification, financial viability, and trading history. 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.

Indexes are usually market weighted or price weighted. The S&P 500 Index is a market weighted index (also referred to as capitalization weighted). Therefore, 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%.

The Dow Jones Industrial Average

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 the United States. The DJIA is a price-weighted index. It was originally computed by totaling the per-share price of the stocks of each company in the index and dividing this sum by the number of companies. Unfortunately, the index is no longer this simple to calculate. Over the years, stock splits, spin-offs, and other events have resulted in changes in the divisor (a numerical value computed by Dow Jones used to calculate the level of the DJIA) 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 a greater effect on the DJIA than a $1 change in the price of a $20 stock, although the higher-priced stock may have changed by only 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 index. 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. In general, the Dow is known for its listing of the U.S. markets best blue-chip companies with regularly consistent dividends. Therefore, while not necessarily a representation of the broad market, it can be a representation of the blue-chip, dividend-value 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 the stocks traded on the Nasdaq stock exchange. This index includes some companies that are not based in the United States.

Known for being heavily tech weighted, this index includes several subsectors across the tech market including software, biotech, semiconductors, and more. Although this index is known for its large portion of technology stocks, it does include some securities from other industries as well. Investors will also find securities from a variety of sectors as well, including financials, industrials, insurance, and transportation stocks, 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 Wilshire 5000

The Wilshire 5000 is sometimes called the “total stock market index” or “total market index” because it includes all of the publicly traded companies with headquarters in the United States that have readily available price data. Finalized in 1974, this index represents the entire U.S. stock market and its movement aggregately. Although it is a very comprehensive measure of the entire U.S. market, the Wilshire 5000 is referred to less often than the more popular S&P 500 Index.

A Roundup of Other U.S. Indexes

Generally, there are a few ways to look at indexes broadly. Capitalization is often key, with indexes falling into either large-, mid-, or small-cap buckets. The S&P 500 and Dow Jones Industrial Average are two of the top large-cap indexes, but others include the S&P 100, the Dow Jones U.S. Large-Cap Total Stock Market Index, the MSCI USA Large-Cap Index, and the Russell 1000. Notable mid-cap indexes include the S&P Mid-Cap 400, the Russell Midcap, and the Wilshire US Mid-Cap Index. In small-caps, the Russell 2000 is an index of the 2,000 smallest stocks from the Russell 3000. Other popular small-cap indexes include the S&P 600, the Dow Jones Small-Cap Growth Total Stock Market Index, and the Dow Jones Small-Cap Value Total Stock Market Index.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    The Best Binary Options Broker 2020!
    Perfect For Beginners!
    Free Trading Education, Free Demo Account!
    Get Your Sing-Up Bonus Now!

  • Binomo
    Binomo

    Good Broker. Only For Experienced Traders!

Investors also commonly look to sectors with Standard & Poor’s leading in this realm of the market. Standard & Poor’s manages: the S&P Communication Services Select Sector, S&P Consumer Discretionary Select Sector, S&P Consumer Staples Select Sector, S&P Energy Select Sector, S&P Financial Select Sector, S&P Health Care Select Sector, S&P Industrial Select Sector, S&P Materials Select Sector, S&P Real Estate Select Sector, S&P Technology Select Sector, and the S&P Utilities Select Sector. These indexes represent the S&P 500’s comprehensive sector segregations.

The growth of smart beta index investing has also helped to increase the number of indexes in the market. Smart beta indexes are passive indexes that are built using certain characteristic or fundamental screens that help to improve the quality of index constitution. Advisors Asset Management (AAM) has three smart beta index funds in the market that largely encompass the entire global market for dividend and value investing. AAM’s smart beta index funds include the AAM S&P 500 High Dividend Value ETF (SPDV), the AAM S&P Developed Markets High Dividend Value ETF (DMDV), and the AAM S&P Emerging Markets High Dividend Value ETF (EEMD).

Major Indices

Major US Stock Indices

Major International Stock Indices

You May Also Like

Continue Reading.

Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results. [Read on. ]

Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time. [Read on. ]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®. [Read on. ]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date. [Read on. ]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

Learn What Market Indexes Say About Investing

If you read or listen to the financial media, you might get the impression that the Dow Jones Industrial Average, usually referred to as the Dow, represents the pulse of the market. Other stock indexes like the S&P 500 or the Nasdaq Composite also get mentioned more or less often, depending on their numbers.

These and other reported indexes can give you a good amount of information and insight to use in making more informed investing decisions.

Explaining Index Numbers

First, take a look at what an index number represents. Although there are different ways to calculate index numbers, the numbers always represent a change from an original or base value. The base value represents the weighted-average stock price of all the stocks that make up the index.

The index number has much less importance or meaning than its percent change over time. This movement up or down gives you an idea of how the index is performing. Is the Dow up or down? The index gets calculated on an ongoing basis each day during the stock market’s open hours, to give investors a sense of direction for the market the index represents.

Be aware, though, that most stock indexes, even those quoted as representing the total stock market, only reflect a portion of the actual market. This happens because each index typically holds stocks from certain sectors or categories of the market.

Reading the Indexes

Keep these factors in mind when analyzing and interpreting changes in a given index:

  • Indexes don’t represent the total market. No matter what happens with the big three indexes, stay focused on your stocks or targets for evaluation. Pick any day that all three indexes are down, and you will still see some stocks setting new highs that same day.
  • Indexes react to actual trades. If you listen to some of the financial news commentators, you might think the indexes move on emotion. Investors may want to trade on the expectation of good or bad news, but index movements require actual trades, not just investor feelings.
  • Focusing on day by day, hour by hour, minute by minute clicks of an index makes for a good way to eat up valuable time.
  • Indexes provide a better historical perspective, rather than a forecasting vehicle. They can be especially helpful when viewed over a long historical period when researching trends.

The Informational Pros and Cons

Indexes provide useful information including:

  • Even with their limitations, indexes show trends and changes in investing patterns.
  • They can give snapshots of market activity, even if they don’t tell the whole story.
  • Indexes provide a yardstick for comparison over time.

Indexes, by design, have some seemingly major flaws that make them suspect to some investors as representative of any truly useful information.

  • People decide which stocks to include and which to remove and people make mistakes. Sometimes stocks get included that shouldn’t be and stocks are removed that shouldn’t be, for various reasons. In addition, this process repeats year after year, making it difficult to look back and compare the S&P 500 of 1995 with the S&P 500 of 2004.
  • By weighting the indexes (except for the Dow) by size, disproportion representation goes to large or giant companies. If one of them has a bad day, it can throw off the whole index.

The Major Indexes

The following summarizes the most popular indexes and the market sectors they capture:

The Dow Jones Industrial Average (DJIA) is the oldest and most widely known index. It is also the most widely quoted index and often, whether right or wrong, considered the market barometer.

Originally, it was a simple average of the stock prices in the index, but thanks to stock splits, spin-offs, and other transactions, the index now requires a more sophisticated price-averaging calculation. You can find more information at the Dow Jones Indexes site. The Dow currently holds 30 stocks. However, these stocks represent some of the largest and most influential companies in the U.S.

The Dow is the only major index that is price-weighted, which means if a stock’s price changes by $1, it has the same effect on the index regardless of the percent change for the stock. In other words, a $1 change for a $30 stock has the same effect as a $1 change for a $60 stock.

The calculation of the Dow takes into account numerous stock splits over the years. By adjusting the math, it is possible to keep a historically viable index meaningful.

The Dow stocks represent about one-quarter of the value of the total market, so in that sense, it is a telling factor and big changes can indicate investor confidence in stocks, however, it does not represent investor sentiment regarding any small or mid-size companies.

The S&P 500 is the most frequently used index by financial professionals as a representative of the market. It includes 500 of the most widely traded stocks and leans towards larger companies.

It covers about 70 percent of the market’s total value, so in those terms, it much more closely represents the true market than the Dow. The S&P 500 is a market capitalization or market-cap-weighted index, as are almost all of the other major indexes.

Weighting by market cap gives more importance to larger companies, so changes in Microsoft stock will have a greater impact on the index price than almost any other stock in the index. Even though the S&P 500 is weighted toward larger companies, because it includes so many companies, it provides a more accurate gauge of the broader market than the Dow.

Even though the financial media may emphasize the Dow, you can get a clearer picture of the market by focusing your attention on the S&P 500.

The Nasdaq Stock Market Composite includes all the stocks listed on the Nasdaq market, which totals more than 5,000 companies. Although broad in coverage, the Nasdaq is heavily weighted to technology stocks. It’s a market cap-weighted index and stocks of very large companies like Microsoft and some of the other big technology companies influence the index.

Their influence and the population of small, speculative companies in the Nasdaq make the index more volatile than either the Dow or the S&P 500. The Nasdaq wasn’t designed to represent the overall market, however, it does provide good insight into the mindset changes of technology investors.

Other Indexes

A number of other indexes exist that measure larger or smaller sections of the market. Additionally, mutual fund investors can find a number of funds that track almost any index they want.

The major three indexes above, however, will serve most investors well. Should you want to look at other indexes for comparison, make sure you understand how the index is weighted (most, if not all, will be weighted based on market cap) and how the stocks held by the index were selected.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    The Best Binary Options Broker 2020!
    Perfect For Beginners!
    Free Trading Education, Free Demo Account!
    Get Your Sing-Up Bonus Now!

  • Binomo
    Binomo

    Good Broker. Only For Experienced Traders!

Like this post? Please share to your friends:
Binary Options Guide For Beginners
Leave a Reply

;-) :| :x :twisted: :smile: :shock: :sad: :roll: :razz: :oops: :o :mrgreen: :lol: :idea: :grin: :evil: :cry: :cool: :arrow: :???: :?: :!: