which means that if a stock’s price changes by $1, it has the same effect on the index, regardless of the percentage 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 many stock splits over the years. If you know how to adjust 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 signal. Big changes in the Dow can indicate high investor confidence in stocks. But keep in mind that due to its makeup, it does not represent investor sentiment regarding any small or mid-size companies.
The S&P 500
The S&P 500 is the most frequently used index by financial professionals as the closest representation of the true market. It includes 500 of the most widely traded stocks, and leans toward larger companies. This index covers about 82% of the market’s total value, so in those terms, it is a better measure of the true market than the Dow is. The S&P 500 is a market-cap weighted index, as are almost all of the other major indexes.
The market capitalization, or "market cap," is the total value of company's outstanding shares. It can be used to measure a company's size in the market, as compared to others.
Weighting by market cap gives larger companies more sway in the index numbers. When Microsoft's stock goes up or down, for instance, those changes 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, since it includes so many companies, it is a more accurate gauge of the broader market than the Dow.
So, while the financial media may report more often on the Dow, you can get a better sense of the total market by focusing on the S&P 500.
The Nasdaq Stock Market Composite
The Nasdaq Stock Market Composite includes all of the stocks listed on the Nasdaq market, which totals more than 2,900 companies. Though broad in coverage, the Nasdaq leans towards tech companies. It is also a market. cap-weighted index and therefore most heavily influenced by very large tech companies.
The 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, but it does provide good insight into the mindset changes of people who invest in technology.
There are a number of other indexes that measure larger or smaller sections of the market. Mutual fund investors can also find 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 to compare, make sure you have a good idea of how each index is weighted. Most, if not all, will be weighted based on market cap. You should also know how the index selects the stocks it holds.
The Balance does not provide tax, investment, or financial services or 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.