Stock Market Indexes Explained: The S&P 500, the Dow and the Nasdaq

"The market" does not have a price. Thousands of companies trade on US exchanges every day, each with its own share price, and an index is simply a formula that boils a chosen group of them down to a single number so that it can be tracked over time. The three indexes Americans hear most often, the S&P 500, the Dow Jones Industrial Average and the Nasdaq Composite, are built on different lists of companies using different math, which is why they regularly disagree about how good or bad a day was. Understanding the construction is the difference between reading the headline and understanding it.

What an index is, and is not

An index is a rule set. It defines which stocks are included, how much each one counts and how the number is calculated. Index providers, which are companies such as S&P Dow Jones Indices, Nasdaq, FTSE Russell and MSCI, publish those rules, maintain the lists and update the values continuously during trading hours.

Three things an index is not:

• It is not something you can buy. You invest in a fund that tracks it. Our explainer on index funds, ETFs and mutual funds covers how those funds work.
• It is not the whole market. Even the broadest US index leaves out stocks that fail its size, liquidity or listing requirements.
• It is not a fixed list. Companies are added and removed as they grow, shrink, merge or go private. The S&P 500 of twenty years ago shared many names with today's but far from all.

The S&P 500

The S&P 500 tracks roughly 500 large companies listed on US exchanges. Membership is decided by a committee at S&P Dow Jones Indices using published criteria that include market capitalization, trading liquidity, a US domicile, a public float of a minimum size and a record of positive earnings. Because it covers a large share of the total value of the US stock market, it is the benchmark most professional investors and fund managers measure themselves against.

Its defining feature is float-adjusted market-capitalization weighting. Each company's weight equals its share price multiplied by the number of shares available to public investors, divided by the same figure for the whole index. The practical consequence is that the biggest companies dominate. A handful of the largest names can account for a large slice of the index's daily movement, while the smallest members barely register. When the giants rise together, the S&P 500 can post a strong day even if most of its members fell, and the reverse is true too.

The Dow Jones Industrial Average

The Dow is the oldest of the three, created by Charles Dow in 1896, and the one most often quoted in evening news bulletins. It contains just 30 large, well-established US companies chosen by a committee to represent the broad economy rather than any formula. Despite the word "industrial," the list today spans technology, healthcare, finance, retail and consumer goods.

Its math is the unusual part. The Dow is price-weighted: the index is the sum of the 30 share prices divided by a number called the divisor, which is adjusted over time for stock splits, spin-offs and membership changes so that those events do not create artificial jumps. The result is that a company with a high share price moves the Dow more than a company with a low share price, regardless of how big either business is. A stock trading at a few hundred dollars per share has several times the influence of one trading at fifty, even if the cheaper stock belongs to a far larger company. Most index professionals regard this as a historical quirk rather than a sensible design, but the Dow's long record and name recognition keep it in daily use.

The Nasdaq Composite and the Nasdaq-100

The Nasdaq Composite includes essentially every common stock listed on the Nasdaq exchange, which runs into the thousands. It is market-cap weighted like the S&P 500, but its membership is defined by where a company is listed rather than by a selection committee. Because so many technology and growth companies chose Nasdaq listings over the decades, the Composite is heavily tilted toward that sector, and it tends to rise and fall more sharply than the S&P 500. When headlines say "tech stocks led the market," the Nasdaq is usually the index moving most.

The Nasdaq-100 is a narrower cousin: the 100 largest non-financial companies listed on Nasdaq, also market-cap weighted with rules that cap the largest positions. It is the index behind some of the most heavily traded ETFs in the country, which is why it appears so often in fund names and options markets.

The three compared

Points versus percentages

A move of 300 points sounds dramatic until you ask 300 points of what. Because the Dow's level is many times higher than the S&P 500's, a given percentage move produces a far larger point change in the Dow. The only meaningful comparison across indexes, or across time within the same index, is the percentage change. A 1 percent fall in 1990 and a 1 percent fall today are the same event for an investor, even though the point values differ by an order of magnitude. Financial sites report both; train yourself to read the percentage first.

Price return versus total return

The headline index numbers are almost always price return indexes, which track share prices alone. They ignore dividends. A total return version of the same index assumes dividends are reinvested, and over long periods the gap between the two is substantial because dividends compound. When you compare your own portfolio or a fund to "the S&P 500," make sure you are comparing against the total return version, which is what index funds actually deliver to shareholders who reinvest. Comparing a fund's total return with a price-only index flatters the fund.

Beyond the big three

Several other indexes appear regularly in fund names and financial coverage:

• Russell 2000: about 2,000 smaller US companies, the standard benchmark for small-cap stocks. The Russell 1000 covers the largest companies, and the Russell 3000 combines the two.
• Total market indexes such as the CRSP US Total Market Index or the Dow Jones U.S. Total Stock Market Index: nearly every investable US stock, used by total-market index funds.
• S&P MidCap 400 and SmallCap 600: S&P's mid-sized and small-company indexes, which apply the same earnings-quality screen as the S&P 500.
• Sector and style indexes: slices of a parent index by industry, such as energy or healthcare, or by characteristics such as value, growth or dividend yield.
• Equal-weight versions: the same stocks as a parent index with every company given the same weight, which removes the dominance of the largest names and behaves quite differently from the cap-weighted original.
• International indexes from MSCI and FTSE, which play the same role for developed and emerging markets outside the US.

Why construction matters to your money

Index design is not an academic detail. It decides what you own when you buy an index fund and how that fund behaves.

• Concentration risk. A cap-weighted index rewards whatever has already gone up. In periods when a few companies dominate, an S&P 500 fund is less diversified than its 500 names suggest. An equal-weight or total-market fund spreads the bets differently.
• Reconstitution effects. When an index adds or drops a company, every fund tracking it must trade on the same day, which can move prices around the change date.
• Benchmark honesty. A fund that calls itself a large-cap growth fund should be measured against a large-cap growth index, not against the Dow. Reading a fund's fact sheet for its stated benchmark tells you what it is actually trying to beat.
• Headlines and emotions. A day when the Dow falls sharply but the broader indexes are flat is often a story about one or two high-priced stocks. Knowing that keeps a dramatic headline from prompting a decision you would not otherwise make.

Reading the daily numbers

The next time a market report crosses your screen, run through four questions. Which index is it? What was the percentage move, not the points? Was the move broad, meaning most stocks participated, or driven by a few heavyweights? And does it affect the funds you actually hold, which are tied to specific indexes named in their documents? The mechanics of how those trades get executed and settled are covered in our guide to how the US stock market works. The indexes are the scoreboard; understanding how the score is kept is what turns noise into information.