Im sure by now, for whatever length you have been interested in the stock market that you have heard at some point in time something along the lines of, “the S&P 500 fell 75 points today” or “the Dow has risen 20% today” or you have some questions like “whats the difference in the stock market indexes?” or “what is a stock market index?” wether you have heard these or not im sure you are confused about what the “Dow” or “S&P” actually is. In reality its very easy to understand.
All stock market indexes are basically just a big box or basket which certain groups of stocks are held, for instance the S&P 500 index is the top 500 biggest US companies all in one “index” or a list. You can buy shares of these indexes which in return, you will be buying a equal part in all the companies on that “index” or list.
There are many, many different stock indexes, (S&P 500, NASDAQ 100, Russell 2000, Etc.) However with all the different options there are the Dow is the most recognized one, it is included in the majority of stock market reports, the Dow is used to measure how well the US stock market is performing.
*Created in 1896, the Dow is the oldest index there is. Despite being that old there is still only 1 original stock the remains… Its General Electric (GE)
The Dow, which stand for the Dow Jones Industrial Average is not really that Industrial anymore, companies such as Nike (NKE) and Verizon (VZ) are listed on the Dow, companies of which are not industrial.
The Dow Divisor
When you hear something like this, “the Dow has fallen 200 points today” most people assume that means $200 down when in reality it does NOT. The Dow has something called “The Dow Divisor” so what happens is that the Dow, S&P 500, Etc. are priced by the total value of all the stocks inside that index or list. In order to keep the price stable incase a company issues a stock split (a stock split is just a term for when a company lets say company ABC has shares priced at $10 per share, if I as an investor owned 100 of these shares then I would have $1000 worth of ABC stock. If the company wants to raise the share price of ABC lets say to $100 per share something called a “stock split” would occur, which instead of my 100 shares at $10, the company raises the share price to $100 and I would only have 10 shares instead of the 100. Does that make sense? the stock split is there to even out the amount of shares when a company decided to raise or lower the stock price of their listing.) The Dow Divisor is equal to 0.14602, if you take that number and multiply it by the amount of “points” The Dow has moved that day then you will get the Dollar amount of the move. For Example: if the Dow fell 200 points today then (200 x 0.14602 = $29.20) I am not sure why they use this method, it just makes things a bit more difficult, but that is what the people in charge have decided and we just gotta follow.
The S&P 500 index, also known as the Standard and Poor’s 500 index originally looked over 200 different stocks, which turned out to be too much at the time when computers did not exist so they lowered down to 90. A man named Henry Poor owned a publishing company in the early 1900s that displayed companies financial information to the public, this became a huge success and Poor started to to they every year. In 1929 the stock market underwent a huge crash and Henry Poor lost his company, Taken over by Standard Statistics they joined with Henry Poor’s list of stocks. This is when the Standard and Poor’s 90 (S&P 90) index was born. With the help of computers, by 1957 the Standard and Poor’s 500 (S&P 500) index was introduced, which tracked and followed the leading 500 companies in the market (at the time they were the first and only to update stats for every stock, every hour) this was intended to represent the broader economy of the US Markets.
There are some requirements order to be listed on the S&P 500 list, not only does you company have to be selected by the committee at Standard and Poor’s, but the company also must:
- Have at LEAST $5.3 Billion total in Market Cap ( Market Cap is just the amount of shares held by investors multiplied by the share price.)
- Have positive earning in the four (4) most recent financial quarters (every 3 months)
- Must be a US company
The S&P 500 is a “weighed index fund” which means that companies with a higher or larger market cap will have a greater affect on the index rather than a smaller company with lower market cap.
The NASDAQ Composite is composed of more than 5000 stocks, ALL of them are listed on the NSADAQ Exchange, The composite features “equities” or positions such as REIT’s or (Real Estate Investment Trusts) as well. One big difference in the composite from the S&P 500 is that on the NASDAQ Composite the company does NOT have to based in the US in order to be listed. The Composite and S&P also have things in common as well, such as both of them are “weighted Indexes” that we covered earlier on, companies with larger market caps will weigh on the index more than smaller companies with smaller market caps.
The NASDAQ also has another index as well, The NASDAQ 100. The NASDAQ 100 features the Largest and most actively traded companies on the NASDAQ exchange. They find the largest companies based off of market cap (they do a lot with market cap) and these are either US or Foreign Companies. This is a very young index, launched in 1985 compares to the Dow or S&P, for all the companies listed on this index, it is VERY easy to stay listed, all a company has to do is make sure their average daily trading volume passes 200,000 shares per day, that might sound like a lot to some people but trust me its not, especially for big companies like Amazon (AMZN) Tesla (TSLA) and Netflix (NFLX)
On the Russell 2000, this is where small cap companies get on a index ( a small cap company is a company with a market cap between $300 Million and $2 Billion) Small companies are more vulnerable to changes in the market, since the Russell 2000 is home to numerous small companies, when the market the moves.. the Russell 2000 moves. This is one of the most volatile indexes on the US Market ( Volatile means able to move up or down very quickly )
*The average market cap on the Russell 2000 in around $1.4 Billion and has companies from every industry.
Although these are pretty big companies that are listed on here, in the grand scheme of the stock market these guys are tiny:
- Papa John’s Pizza (PZZA)
- Krispy Kreme Doughnuts (KKD)
- Cracker Barrel Old Country Store (CBRL)
Those are just a few of the many companies that are listed on the Russell 2000, as you can see they are not companies that you’ve never heard of but they are certainly not companies like Amazon and Microsoft.
Many people have not heard of the Wilshire 5000 index, however it is the largest index in the world! (by Market Cap) The Wilshire 5000 does NOT include 5000 companies but only 3600 of them, although at one time there was 5000 listed on this index and at other times even more ( the max at one time was 7562 COMPANIES!! that A LOT ) The Wilshire 5000 is sometimes referred to as the Total Market Index, This index keeps track of pretty much every stock on an American Stock Exchange, the only condition is that the stock price is easily available that means many companies listed on the OTC Markets are not included. As we have talked about earlier, the Wilshire 5000 is also a Market Cap Weighted index like the S&P 500 and NASDAQ Composite meaning that larger companies will have a greater influence on the index rather than a smaller, less valuable company.
We have discussed all the indexes that you will see more than once in your investing career. All indexes are, are just big boxes that group certain stocks together and they allow investors like you and I to purchase a little piece of every stock in there just by buying a single share of a index. The Stock Market is Wonderful.
Don’t be selfish, share this with your friends and spread the wisdom. share buttons below!