American stock indexes

3.9

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Now that you’ve been briefed about the various stock exchanges in America, the next logical step in our journey towards learning about the American stock market is to know all about its stock market indexes. As you’ve already read before, stock indexes are great indicators that allow you to gauge the performance of an economy. That’s not all. Knowing about indexes helps you make informed investment decisions. On that note, let’s head on with our chapter on American stock market indexes.

American stock market indexes: An introduction

Just like how the major Indian stock exchanges, the BSE and the NSE, possess broad market and sector-specific indexes, the U.S. stock exchanges also have their own indexes. Here’s a fun fact for you. In the U.S. there are around 5,000 different stock indexes apart from the four majorly followed ones. Overwhelmed? Don’t worry, we’ll slowly get towards deconstructing them one after the other.   

The major American stock market indexes

Although there are hundreds of various stock indexes, you, as an investor, needn’t follow them all to get a good idea of the American stock market. In fact, there are only about three to four major stock indexes that you should concern yourself with. Here’s a preview of what they are:

  • The Nasdaq Composite Index
  • The S&P 500
  • The Dow Jones Industrial Average
  • The Wilshire 5000

We’ll start with the Nasdaq Composite Index and get going from there. 

The Nasdaq Composite Index

Since you’ve already been introduced to Nasdaq in the previous chapter, we’ll be focusing on the exchange’s index alone here. 

The Nasdaq Composite Index is a broad market index that consists of all of the companies listed in the Nasdaq exchange. Featuring more than 2,500 constituents, the Nasdaq Composite Index is one of the best indicators of the American economy. 

Around 50% of the companies in the stock market index are from the tech space, making it the best index for tracking the American tech industry. In addition to tech, the index also features several prominent companies across sectors such as consumer services, healthcare, industry, consumer goods, and finance.

One of the major factors that sets the Nasdaq Composite Index apart from the other indexes is the fact that it also includes companies that are not headquartered in the U.S.A. In addition to stocks, the index also consists of the following securities -

  • American Depositary Receipts (ADRs) 
  • Limited Partnership Interests 
  • Real Estate Investment Trusts (REITs) 
  • Shares of Beneficial Interest (SBIs) 
  • Tracking Stocks

The S&P 500

If you can recall from the previous modules, the letters ‘S&P’ stand for Standard & Poor’s. The S&P 500 index consists of the top 500 companies in the American stock market. Although the index has only 500 constituents, it still represents around 80% of the total U.S. stock market, making it a very good indicator. That said, the constituents of the S&P 500 are mostly large-cap companies across multiple sectors and sub-sectors. 

The S&P 500 is constructed using the market capitalization weighting method. The companies in this index are all ranked by their total market capitalization and are accordingly given weights. Companies with high market capitalization are accorded heavier weights and companies with low market capitalization are assigned lower weights. And so, companies with heavier weightage tend to move the index a lot more than companies with lower weightage.   

However, market capitalization is not the only factor that’s taken into consideration during the construction of the stock market index. There are other factors such as public float, liquidity, sector classification, trading history, and financial viability as well.

The Dow Jones Industrial Average (DJIA)

Consisting of the top 30 companies in the U.S., the Dow Jones Industrial Average (DJIA) is easily one of the most popular and widely used indexes. Unlike the other indexes on this list, the DJIA is price-weighted instead of being weighted according to the market capitalization. 

This effectively means that the companies in the DJIA are weighted and ranked in accordance with their market price. For instance, a company whose share price is around $150 would rank high and carry a higher weightage compared to a company whose share price is just around $50.

Instead of concentrating on just a single exchange, the stock market index takes all of its 30 constituents from both the Nasdaq and the NYSE. Conceptualized in the year 1896 by Charles Dow and Edward Jones, the DJIA is the second oldest, continuously used index in the world.

Although it is widely used as a performance benchmark,  the index also has its fair share of detractors. Many experienced traders and investors believe that the DJIA is not a good measure of the U.S. economy since it takes only 30 companies into consideration. Others, on the other hand, believe that weightage based on market capitalization is a far better metric for evaluation than weightage based on price.

The Wilshire 5000 Total Market Index 

Though the Wilshire 5000 Total Market Index (TMWX) is not as popular or widely used as the other three in this list, many experts believe that it represents the American stock market in a better manner. Such a view stems from the fact that the index factors in all of the publicly traded companies in the U.S.A, making it one of the most comprehensive indexes in the world.  

Contrary to its name, the Wilshire 5000 doesn’t consist of 5,000 companies. Instead, it only features around 3,500. That said, when it was first introduced in the year 1974, it did in fact contain 5,000 stocks. Again, as with the Nasdaq Composite Index and the S&P 500, the Wilshire 5000 also makes use of the market capitalization weighted method. 

Other American stock indexes

All of the four indexes that we’ve seen above are widely used broad market indexes. In addition to these four, there are several other minor indexes as well. Here’s a quick look at some of them.

  1. Dow Jones Transportation Average
  2. Dow Jones Utility Average
  3. Dow Jones 65 Composite
  4. Dow Jones Total Stock Market
  5. Dow Jones Barron’s 400
  6. S&P 100 Index
  7. S&P Midcap 400
  8. S&P SmallCap 600
  9. S&P SuperComp 1500
  10. Nasdaq 100
  11. NYSE Composite
  12. Russel 3000
  13. Russel 2000
  14. Russel 1000

These 14 indexes are merely other minor broad market indexes and are only illustrative and not exhaustive in nature. There are tons of other sector-specific indexes in the American markets too.    

Wrapping up

Now, there you have it - the four major American stock indexes. As an Indian investor looking to put your money into the American stock market, these four are the most important ones that you should be focusing on. Going forward, we’ll be focusing on how you, as an investor, can invest in the U.S. markets. 

A quick recap

  • The Nasdaq Composite Index is a broad market index that consists of all of the companies listed in the Nasdaq exchange. 
  • Featuring more than 2,500 constituents, the Nasdaq Composite Index is one of the best indicators of the American economy. 
  • The S&P 500 index consists of the top 500 companies in the American stock market.
  • Although the index has only 500 constituents, it still represents around 80% of the total U.S. stock market, making it a very good indicator. 
  • The S&P 500 is constructed using the market capitalization weighting method. 
  • Consisting of the top 30 companies in the U.S., the Dow Jones Industrial Average (DJIA) is easily one of the most popular and widely used indexes. 
  • Unlike the other indexes on this list, the DJIA is price-weighted instead of being weighted according to the market capitalization. 
  • Instead of concentrating on just a single exchange, the DJIA takes all of its 30 constituents from both the Nasdaq and the NYSE. 
  • The Wilshire 5000 Total Market Index factors in all of the publicly traded companies in the U.S.A, making it one of the most comprehensive indexes in the world.
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