In order to have an idea of how stocks are doing compared to a week or a year ago, an average or index is used. The Dow Jones Industrial Average, the Standard & Poors 500, and the NYSE index are the most popular and follow the large blue chip corporations. The NASDAQ composite of course is heavily weighted with smaller technology companies.
There are also indexes for specific industry categories such as airlines or banks or auto-mobile manufacturers. Standard & Poors calculates a large number of these. Indexes can be constructed to include only companies of a certain size as measured by market capitalization. So there are large cap indexes, mid cap indexes and a small cap indexes.
An index can be calculated in several ways. An index that is just a simple average of stock prices is called a ‘price weighted index’. The Dow Jones Industrial average is the most well known example of this type. Such an index is easy to calculate but doesn’t reflect market activity that accurately.
For example, if two stocks in the index both move by one percent and one stock is trading at 100 dollars per share and the other is trading at 40 dollars per share, the stock trading at 100 dollars a share will have a greater influence on the average. Such an index also does not take into consideration the market value of the stocks included.
The Standard and Poors 500 is an example of an index which includes the market value of each of its stocks in the calculation of the index value. This type of index will be less influenced by the movement of small capitalization companies and will more accurately represent how the total market value of stocks changes over time. It also includes 500 stocks in the index, which are selected to represent all sectors of the economy. The Dow Jones Average only includes 30 stocks. Many traders feel the Standard & Poors 500 index gives a better picture of the market than the Dow Jones average.
Traders like to keep track of how markets are doing around the world and each country generally has an index that represents the value of companies traded on their local exchanges. The FTSE 100 index measures the value of the 100 largest companies listed on the London Stock Exchange. The Nikkei 225 measures the Japanese stock market.