By Nathan Boardman
As you likely know, stock prices vary. At times, these alterations occur frequently and swiftly, while on other occasions, they occur unexpectedly and can take you by surprise. Nevertheless, with the appropriate expertise and know-how, one can address these issues by comprehending and assessing the general well-being of the stock market. This distinguishes seasoned investors from novices.
Suppose you are a novice in the stock market and wish to acquaint yourself with its intricacies. In that case, it is crucial to grasp specific key market indices that will aid you in swiftly evaluating market performance.
Although there is an extensive array of these indices, there are three that every aspiring trader should familiarize themselves with. The Dow Jones Industrial Average, Nasdaq100, and S&P 500 are all well-known stock market indices.
So, how can you analyze market fluctuations using these indices? Now, let’s delve into the mechanics of the market by analyzing these crucial indices, examining their distinctions, identifying their similarities, and exploring their usefulness for traders.
What Exactly Are These Indices, and What Do They Mean?
The Dow Jones Industrial Average
The DJIA, also known as the Dow Jones Industrial Average, holds significant importance in the world of stock market indices. The index monitors a total of thirty prominent publicly-traded blue-chip corporations, which are listed on both the NASDAQ and NYSE (New York Stock Exchange).
The index was developed in the mid-1880s by Charles Dow and his longtime business partner, Edward Jones. The Dow Jones Transportation Average holds the distinction of being the oldest market index in the United States, with the DJIA following closely behind.
Charles created this index to serve as a helpful representation of the overall state of the United States economy. Many individuals closely observe the DJIA for a variety of blue-chip stocks and regard it as a benchmark index.
Initially utilized for internal purposes, the DJIA index made its debut in 1896 with a mere twelve constituents, predominantly hailing from the industrial realm. These included sectors such as tobacco, sugar, gas, cotton, and railroads.
In the early twentieth century, the economy’s growth rate was closely tied to the performance of industrial companies. Even though there are only a few remaining heavy industry components in the index nowadays, the correlation persists as most investors rely on Dow’s performance to assess the strength of the economy.
NASDAQ100
The NASDAQ, also known as the National Association of Securities Dealers Automated Quotations, was established in 1971 as a substitute for the existing stock transaction system in the United States. This electronic stock market is significant and ranks as the second-largest stock exchange in terms of market capitalization.
The NASDAQ 100 Index is composed of securities issued by 100 non-financial companies that are listed on the NASDAQ exchange.
Components are sourced from a diverse range of industries, encompassing transportation, industrial, biotech, retail, healthcare, and media. Nevertheless, the majority of individuals link the index to its emphasis on hi-tech stocks, which include the renowned ‘FAANG’ stocks.
S&P 500
The S&P 500 Stock Composite Index was first introduced on March 4, 1957. The index is an excellent gauge of the USA stock market’s performance, as it tracks the results of the 500 largest publicly traded businesses in the country.
What Is the Methodology Behind the Calculation of Each of These Indices?
Calculating the Dow Jones Index
The Dow Jones is determined by adding up the prices of the 30 stocks that comprise the index and then dividing this total by the “divisor.” It considers factors such as stock mergers and splits, which play a crucial role in calculating the scaled average in the Dow. If the Dow is not calculated as a scaled average, the index would experience a decrease in the event of a stock split.
NASDAQ Calculation
The NASDAQ is calculated using a widely used method called market capitalization weighting. To calculate the total value of each stock’s shares, you need to multiply the share weight by the closing price of each security. Afterward, it is split by a divisor used for indexing purposes.
Calculation of the S&P 500
The S&P 500 is determined by multiplying the current market value or share price of each company’s outstanding shares. Moreover, as a market-weighted index that takes into account freely traded shares, it exclusively encompasses publicly accessible stocks.
How Do They Differ?
Although these U.S indices share a strong correlation, they possess individual characteristics due to their one-of-a-kind composition. The S&P 500 is comprised of a large number of stocks, which helps to insulate it from the effects of daily market fluctuations.
In contrast, Dow Jones has a mere thirty stocks. As a result, stock performance can significantly influence their price. Currently, the top ten stocks in the index have a significant impact on over half of Dow’s total value, highlighting the crucial role that individual stock performance plays in determining the fate of this index.
The NASDAQ has a broader scope in comparison to the Dow, given its abundance of constituents. Nevertheless, the influence brought about by more minor factions remains evident. The top ten stocks in the index have a significant impact on NASDAQ’s overall value, making price fluctuations in these stocks crucial for traders on the exchange.
