Stock market indices are groups of stock that serve as an indicator of performance and trends in a particular category, usually through a weighted average. They are used as benchmarks for specific parts of the economy or the overall economy, depending on the stocks chosen to make up the index. They may also be used as references for index funds, exchange-traded funds (ETF's), and for more complex financial vehicles such as derivatives.
The number of stocks in indices varies greatly, and the number does not necessarily correlate to its breadth. The diversity of the chosen stock (or lack thereof, for a specialty index) is generally more important than the number.
As overall economic indicators, some major indices are:
- Dow Jones Industrial Average – The most often quoted index, often shortened to the Dow. This index is composed of 30 of the largest stocks over a range of industries, such as 3M, Microsoft, Chevron, McDonalds, American Express, Boeing, and Verizon. For this reason, it is also called the Dow 30.
- S&P 500 – This includes 500 large-cap (capitalization) companies that are widely held and traded on the New York Stock Exchange (NYSE) and NASDAQ, chosen to be representative of the overall market. It is similar to the Dow, and arguably a better overall market representative because of the larger number of companies. The S&P 100 is a narrower subset of the S&P 500.
Other S&P indices include the S&P 600 for small-cap stocks and the S&P 400 for mid-cap stocks. The definition varies, but mid-caps are generally considered to have market capitalization of between $1 and $10 billion, with large- and small-caps defined on either side of those values.
- NASDAQ Composite – The NASDAQ Composite index includes all companies listed on the NASDAQ exchange. It tends to be associated with growth stocks because of its higher ratio of technology companies. As a result, it is typically a more volatile index.
- NASDAQ 100 and NASDAQ Financial 100 – These are split into the 100 largest non-financial and financial companies in the NASDAQ, respectively. Since the NASDAQ is so heavily associated with technology stocks, the NASDAQ 100 is frequently mentioned while the Financial 100 is not.
- NYSE Composite – Similar to the NASDAQ composite, this index includes all stocks traded on the New York Stock Exchange.
- Russell 1000/2000/3000 – Similar to the S&P, with the Russell 2000 index for smaller-cap, the Russell 1000 for large-cap (with a select subset for mid-cap), and the Russell 3000 as a comprehensive selection of 3000 companies.
- Wilshire 5000 – This index is as comprehensive as it gets within the U.S. stock market, including all of the companies in the U.S. that are publicly traded.
Indices are occasionally rebalanced to keep one stock from having too much influence in the index, and occasionally representative companies will be replaced.
There are far too many types of indices to cover here, but here are some other examples.
- Sector Indices – These are targeted at more specific areas than the above indices. For example, Dow Jones has dozens of indices ranging from sector indices such as consumer goods, health care, and technology; specialty indices including pharmaceuticals and aerospace/defense; and blue-chip indices for superior-ranked stocks.
- Global Indices – May include foreign companies, or be exclusively composed of foreign companies.
The bottom line is that different stock indices have different components, are weighted and calculated differently, and are put together to serve different markets and purposes. Make sure you understand the underpinnings of any particular stock market before investing based on its trends. Moreover, as studies have shown that it is exceedingly difficult for investors to “beat the market” with their own stock picks, it is generally smarter to invest in index mutual funds, as they replicate various markets quite effectively.
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