The S&P 500, the Dow and the Nasdaq: What Indexes Measure

Three stocks. The biggest gains 2%; the other two each fall 4%. The headline says the market rose 0.8%.

One small gain has beaten two bigger falls.

The headline comes from an index, where stocks need not have equal say. One stock can count for more than the other two combined. Give these same stocks equal influence and the result becomes a 2% loss. Both headlines can be right.

An index is a measuring basket

A stock index combines the performance of a defined basket of stocks into one number. Each member is an index constituent. Its index weight tells you how much influence it has, as a percentage of the basket.

Index points are units on a chosen scale. A level of 5,000 is neither a $5,000 share price nor a count of 5,000 companies. What matters is the percentage change from the starting level.

You cannot buy a calculation. An index fund is a mutual fund or exchange-traded fund (ETF) that holds investments and seeks to track an index.

"The market" is shorthand. A US large-company index covers one part of the stock market. It cannot speak for every company worldwide or the whole economy. Name the basket before interpreting the headline.

Weights decide the result

Market-cap weighting gives each stock a weight in proportion to its market capitalization, the value of its outstanding shares. Float-adjusted weighting counts only the shares available for public trading. A bigger share of the basket's market value means more influence.

In our made-up three-stock index, A starts at 80% of the basket's market value; B and C each have 10%. Think of $80, $10 and $10 out of each $100. Over one day, A gains 2% while B and C each lose 4%, with no dividends, company events, membership changes or rebalancing.

Equal weighting gives each member the same weight at rebalancing, when the index resets its weights. Prices then move and the weights drift apart. For three stocks, equal starting weights mean one-third each.

A fills four-fifths of the first bar, but only one-third of the second. Equal weight means equal amounts of money in each stock, not equal numbers of shares.

To calculate the day's return, multiply each starting weight by its stock's return, then add:

• Stock A: 0.80 × 2% adds 1.6 percentage points.
• Stock B: 0.10 × (−4%) subtracts 0.4 percentage points.
• Stock C: 0.10 × (−4%) subtracts another 0.4 percentage points.

The cap-weighted index gains 1.6 − 0.4 − 0.4 = 0.8%. One winner outweighs both losers. An index is not a majority vote.

Starting weights matter: A's share of the basket grows during the day. Using its ending weight would give its gain too much credit.

With equal starting weights, the calculation is (2% − 4% − 4%) ÷ 3 = −2%. The two falling stocks now have two-thirds of the influence.

Start both indexes at 1,000 points. The cap-weighted version ends at 1,000 × 1.008 = 1,008; the equal-weight version ends at 1,000 × 0.98 = 980. Same stocks, same day, opposite headlines.

Three headlines, three baskets

The familiar names differ in both membership and weighting. Here, "cap" means market capitalization.

A committee selects the S&P 500's companies from eligible candidates. It covers large US companies, but is not an automatic list of the 500 largest. Some members have more than one share class in the index, so 500 companies can mean more than 500 stocks.

The Dow is short for the Dow Jones Industrial Average. Despite the name, its companies extend beyond industrial manufacturers.

Price weighting gives a higher-priced share more influence, even if its company is smaller.

Suppose one stock costs $200 and another $50. The $200 stock has four times the weight. A 1% move changes its price by $2, versus $0.50 for the other stock, so it has four times the impact. A $1 rise in either stock has the same effect on the Dow.

A two-for-one stock split halves the share price without cutting shareholders' wealth. The Dow adjusts its divisor, the number that scales its calculation, so the split itself leaves the index level unchanged. The lower-priced stock then has less weight in future percentage moves.

Nasdaq names an exchange as well as indexes. The Nasdaq Composite covers eligible common shares and similar ownership stakes listed there, from US and international companies. Its basket includes financial companies and excludes ETFs.

The Nasdaq-100 is a separate index of large Nasdaq-listed non-financial companies. A shared name does not mean the same basket.

Read the headline with its limits

A long member list can still leave a few giants in charge. Equal weighting reduces their dominance and gives smaller companies more say. It changes the risks you take; it does not remove them or promise better returns.

The familiar headline versions track prices. A total-return version also counts dividends and other distributions as reinvested. Match those definitions when comparing returns, or you will credit one index with income you left out of the other.

Points need a starting level, too. A 100-point gain from 1,000 is 10%; from 10,000, it is 1%. A bigger point gain need not mean a better day.

A market headline comes with three questions:

• Basket: Which index, and which stocks does it include?
• Weights: Which members have the most influence?
• Return: Does the number measure prices alone or include reinvested distributions?

Read "The Dow rose 1%" as a price gain for a basket of 30 stocks, with higher-priced shares carrying more weight. It does not tell you how many of the 30 rose.

To see what the companies inside the basket do, look at their sectors and industries.

In short

• An index's result depends on which stocks it includes and how much each counts.
• The S&P 500, Dow and Nasdaq Composite measure different baskets with different weights.
• A few large weights can lift an index even when most members fall.
• Compare percentage moves on the same basis: price return or total return.
• You invest through a product that tracks an index; you cannot buy the calculation itself.