By gaining a clear understanding of how indices are created and how they differ, you will be on your way to making sense of the daily movements in the stock market.
According to Investopedia, A market index is a weighted average of several stocks or other investment vehicles from a section of the stock market, and it is calculated from the price of the selected stocks. Market indexes are intended to represent an entire stock market and track the market’s changes over time.
The major stock market indices are the:
- Dow Jones Industrial Average (DIJA)
- Standard and Poor’s 500 Index (S & P 500)
- Nasdac Composite Index
- Russell 2000
- Wilshire 5000
..and on this episode, we shall be detailing on the DIJA and S&P 500, while other indices will be discussed in subsequent chapters.
The Dow Jones Industrial Average (DJIA) is one of the oldest, most well-known and most frequently used indices in the world. It is an indices for the stocks of 30 of the largest and most influential companies in the United States.
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.
A change in the Dow represents changes in investors’ expectations of the earnings and risks of the large companies included in the average. Because the Dow is made up of some of the most well-known companies in the U.S., large swings in this index generally correspond to the movement of the entire market, although not necessarily on the same scale.
The S&P 500
Standard & Poor’s 500 Index (known commonly as the S&P 500) is a large and diverse indices made up of 500 of the most widely traded stocks in the U.S., it represents about 80% of the total value of U.S. stock markets. The S&P 500 index is market weighted, as every stock in the index is represented in proportion to its total market capitalization. Therefore, if for example the total market value of all 500 companies in the S&P 500 increases by 4%, the value of the index also increases by 4%.
In general, with the U.S deemed by many to be the capital of stock trading, the S&P 500 index gives a good indication of movement in the U.S. marketplace as a whole. The S&P 500 index includes companies in a variety of sectors, including energy, industrials, information technology, healthcare, financials and consumer staples.
- Investopedia, An Inroduction to Stock Market (2018)