A stock market index tracks the financial performance of a specific market. It’s a quick way to look at the average of a market performance to see how it is performing. Simply put, each index is the average performance of a group of companies.
For example, the S&P 500 measures the performance of the 500 largest U.S. publicly-traded companies, the Nasdaq tracks the performance of the Nasdaq stock exchange, and the Dow Jones measures the performance of the 30 largest U.S. companies traded on the Nasdaq and New York Stock Exchange.
Since stock market indexes such as the S&P 500 and the Nasdaq are only representations of the performance of a grouping of stocks, investors can’t trade them, but they can trade index funds or exchange traded funds (ETFs) that track these indexes, such as the Vanguard 500 Fund which tracks the S&P 500.
Many other countries have their own stock market indexes. For example, The ADX General Index is a stock market index which tracks the performance of stocks listed on the Abu Dhabi Securities Exchange.
What is the S&P 500?
The Standard & Poor’s 500 Index – known as the S&P 500 – is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies, which basically means that it is a measure of the average performance of 500 U.S.-based companies’ stock.
Since the stocks included in the S&P 500 are weighted, they each have different amounts of impact on the index performance. For example, a company that has a 6% weighting has a greater impact on the index performance than a company that has a 1% weighting. The top three largest components of the S&P 500, as of June 30, 2020, include Microsoft Corp. (MSFT) with an index weighting of 6%, Apple Inc. (AAPL) with an index weighting of 5.8% and Amazon.com Inc (AMZN) with an index weighting of 4.5%.
Most investment professionals use the S&P 500 as their benchmark, since it includes stocks in all sectors, and the 500 stocks account for approximately 80% of the market value of the U.S. equities market.
When you hear investors say things like “the market is up today!”, they’re probably referring to the S&P 500’s performance that day.
You’re probably wondering, how does the S&P measure the average performance? The S&P 500 uses a specific calculation, but fortunately, the total market cap for the overall S&P 500 as well as the market caps of individual companies are published often on financial websites.
All indexes regularly undergo changes to their structures, and the S&P 500 is no different. Each year the S&P 500 changes around 3% of its components – about 15-20 companies – due to mergers or acquisition strategies of companies or when smaller companies are replaced with larger ones.
What is the Nasdaq?
The Nasdaq is a stock exchange located in the United States, and includes approximately 3,300 listings. The Nasdaq Stock Exchange was actually the first stock exchange allowing investors to trade over a computer. In its early days, the Nasdaq used to primarily include only tech stocks, such as Apple and Google, but now includes stocks from a variety of industries.
The term Nasdaq is also used to refer to the Nasdaq Composite which is an index of more than 3,000 listings on the Nasdaq.
The Nasdaq Composite Index – like the S&P 500 – uses a market capitalization weighting methodology. To be eligible for the Nasdaq Composite Index, the security’s U.S. listing must be exclusively on the Nasdaq Stock Market and – unlike the S&P 500 – can be either an American depositary receipt, common stock, limited partnership interest, ordinary share, real estate investment trust, share of beneficial interest or trading stock.