If you try to keep current, but aren’t all that familiar with the stock market, then you must have heard of ”the Dow” or the “NASDAQ“. You hear commentary on the news about “the market” or sometimes a reference to the S&P 500, but do you know what these numbers mean or where they come from?
The stock market is a reflection of current economic activity. The price that we see for a share of stock in a company is just the value of owning a piece of that company and their products. The collection of publicly traded companies is what we know as the stock market, and each company who has publicly traded shares of stock must be listed on a stock market exchange.
There are many stock market exchanges. In the United States, we have several stock exchanges registered through the Securities and Exchange Commission, including the Chicago Stock Exchange. Other exchanges in the United States include the NASDAQ and the New York Stock Exchange (NYSE).
Before trading publicly, a stock must be listed on an exchange, and each exchange has certain listing requirements, such as size, market value, and stock price. For instance, Facebook, one of the most recent and largest IPOs, chose to be listed on the NASDAQ exchange.
When you hear about “the market”, they are not talking necessarily about the stock exchanges themselves, or even every stock for that matter. They are actually talking about the stock market indexes.
An index is basically a selection, or portfolio of stocks, that represents the market, a sector, a region, etc.
A stock market index gives us a way to measure changes in the market as a whole, and is calculated as a weighted or scaled average of the stock prices included in the index.
While there are only a handful of registered stock market exchanges, there are thousands of indexes.
The major stock market indexes commonly mentioned in the news are the Dow, the S&P 500, and the NASDAQ. Each one differs in selection, size, and market coverage.
The Dow, or Dow Jones Industrial Average (DJIA), is a selection of thirty large-cap, blue-chip stocks. Although they are not actually industrial, these companies cover a wide spectrum of the American economy. It is very popular among investors because these blue-chip companies very accurately reflect the performance of the stock market.
Other stock market indexes are broader than the Dow. The S&P (which stands for Standard and Poor) 500 provides broader, more diverse market coverage. It includes 500 companies, each of them selected to represent about 70% of the American economy. Like the Dow, the S&P also very accurately represents the performance of the stock market, and investors watch it very closely, much like the DJIA.
The NASDAQ, or more precisely, the NASDAQ Composite Index, is a third popular stock market index. The NASDAQ Composite is an index that includes all the companies on the NASDAQ stock exchange. The NASDAQ differs from the S&P and the DJIA because of the number of tech stocks and growth stocks that are included, as well as the fact that it includes a number of foreign companies. As a result, it is more volatile than the S&P or the Dow.
Each type of index provides us with a slightly different way of understanding market performance.
The indexes reflect current trends and investor sentiments. We can use these indexes as a way to begin investing, or as an objective way of judging our own portfolios.
The stocks included in the indexes are selected by professionals to show how the market is doing overall. If you have no idea where to start, and you want professional advice, then you can look no further than the S&P 500, which historically has averaged returns of 10-11%. If you’re just getting started in investing, it may be worthwhile to choose a portfolio that reflects the S&P 500, or choose an index fund that does. You’ll most likely do as well as the market, and if you buy and hold, whatever money you lose in a down market, you’ll get back when the markets eventually go back up.
Not only that, you can use a stock market index as a benchmark to judge the performance of your own portfolio. If you look at your SprinkleBit portfolio, you will notice a percent next to your total portfolio value. This is the percent change in the value of your portfolio from day to day. You can compare this to the percent change of your chosen index to see if you can “beat the market.”
Keep in mind: It is difficult to beat the S&P consistently without taking on riskier investments.
Whether you choose your own portfolio, or follow an index, it’s very useful to have the Dow and S&P there to remind you of how you could be doing.