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There are a number of indexes used when discussing the performance of the stock market. Indexes are used to show trends and changes in the stock market. It is a listing of stocks and a statistical reflection of those stocks the index is monitoring.
Essentially an index is a number that represents a change from the original base value of that particular index. The number is not the main focus, but the percent change over time. As the number moves up or down you will get an understanding of how the index is performing. If it is on the rise over a substantial period of time, a bull market is said to be occurring. If it has been going down for a time, then it is a bear market.
The index you are interested in (as mentioned above, there are many) is only representative of a portion of the market; that is important to remember. Some indexes are more specific than others; others are more widely reported in financial media releases. Here are a number of the more commonly reported indexes:
1. The Dow Jones Industrial Average (most commonly referred to as the Dow) is the oldest reporting index and the most well known. The Dow is an index of thirty of America’s stocks that reflect the mixture of the economy. Big names are among this thirty, (McDonalds, Microsoft, Wal-Mart) and the names do change over time. The Dow is representative of only about a quarter of the market value and is the only major index that is price weighted. This means that if a stock’s price changes by $1, regardless of how much the original stock price is worth, it will have the same effect on the index. Other indexes are market-share (or market-capped) weighted, which may give a more realistic indicator of the market movement. This means that the price is weighted relative to the number of shares rather than the total value. Therefore bigger company movements, will have a great influence on the index.
2. Standard & Poor’s 500 or S & P 500 is the most frequently used index as it is more representative of the stock market. This index tracks the prices of 500 stocks of America’s largest companies. These 500 companies account for approximately seventy to eighty percent of the total market value in the USA.
3. The NASDAQ index looks at all the stocks on the NASDAQ market. There are more than 5,000, giving it a much broader coverage than the Dow and the S & P 500. However the NASDAQ mostly comprises of technology stock which means Microsoft stocks and other big technology companies can influence this index making it more unpredictable. The NASDAQ will give you a good idea of where technology investors are putting their money, but it is not designed to represent the stock market as a whole.
4. Wilshire 5000 tracks approximately 6,500 stocks of American companies of various sizes. Because of it’s inclusion of all company sizes, the Wilshire 5000 is considered the most representative of all the indexes.
Other indexes you may hear about will include overseas markets. For example there is the EAFE (Europe, Australasia and Far East) index, which is an index for the stocks of major developed eastern countries. There are other indexes for individual countries such as the British FTSE 100, the Hang Seng Index (Hong Kong), the Japanese Nikkei, the French CAC 40 and the German DAX.
All stock market indexes are representing a specific stock, whether it is country- based, size of company or price-weighted, the index is specific to its own particular market.
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