What is a stock market index?
An index is a list of stocks plus a rule for weighting them, maintained by an index provider. Its level is a calculated number, not a price anyone trades at; what matters is how it changes. “The S&P 500 rose 1% today” means the weighted basket gained 1%, even if many of its stocks fell.
Indexes are the market’s scoreboard, the benchmark funds and investors compare themselves with, and the recipe that index funds copy. They also anchor the words you hear on the news: a bull or bear market is usually measured on a broad index such as the S&P 500.
S&P 500, Nasdaq-100, Dow Jones and Russell 2000 compared
Large, mid and small refer to market capitalization, the value of all a company’s shares (market cap explains it). The four headline indexes:
- S&P 500: about 500 large US companies, chosen by a committee at S&P Dow Jones Indices under published rules on size, liquidity and profitability, and weighted by float-adjusted market cap (only shares available to the public count). The most common gauge of the US market.
- Nasdaq-100: 100 of the largest non-financial companies listed on Nasdaq, weighted by market cap with caps that limit the biggest weights. Heavy in technology, so its path can differ a lot from the S&P 500.
- Dow Jones Industrial Average: 30 large, well-known US companies chosen by a committee and weighted by share price. The oldest of the four, launched in 1896, but narrow.
- Russell 2000: the small-company part of the broader Russell 3000, about 2,000 stocks weighted by market cap and rebuilt on a fixed schedule. The usual gauge of US small caps.
Cap-weighted vs price-weighted: why it matters
In a market-cap-weighted index, each stock counts in proportion to the company’s market value. In a price-weighted index such as the Dow, each stock counts in proportion to its share price, whatever the company’s size.
Hypothetical, drawn below: company A trades at $50 and is worth $60 billion, B at $350 and $14 billion, C at $100 and $26 billion. Weighted by value, A is 60% of the index and B 14%. Weighted by price, the three prices add up to $500, so B is 70% ($350 ÷ $500) and A only 10%. The smallest company dominates the price-weighted version simply because its shares cost more.
That changes what moves the index. If A rises 10% and nothing else moves, the value-weighted index gains about 6% (10% × 60%), the price-weighted one about 1%. A split lowers a company’s share price and so its weight in a price-weighted index, while its weight by value stays the same: see stock split.
Why a few big stocks can move the whole index
Because large companies carry large weights, a cap-weighted index can be concentrated: in the S&P 500 the biggest companies make up a large share of the total, so a move in a handful of them can lift or sink the index while most stocks go the other way. “The index is up” does not mean “most stocks are up”.
Caps such as the Nasdaq-100’s limits on the largest weights reduce this but cannot remove it. Many investors also look at an equal-weighted version of an index, and at the sector mix, which stock market sectors breaks down.
How to invest in an index: index funds and ETFs
You can’t buy an index itself: it is a list and a calculation. You buy a fund that holds the index’s stocks in its weights, either a mutual fund or an exchange-traded fund (ETF) that trades like a stock, as drawn below. Well-known ETFs that track these indexes include SPY (S&P 500), QQQ (Nasdaq-100), DIA (the Dow) and IWM (Russell 2000), named here as examples of instruments, not recommendations.
A fund charges a yearly expense ratio and can trail its index slightly, and an ETF has a bid-ask spread when you trade it. What is an ETF explains how these funds work, and index fund investing covers the long-term approach. SPY and QQQ are also among the most traded US instruments; SPY day trading looks at them from a trader’s side.