What is a stock market index?
A plain-English guide to the S&P 500, Nasdaq, Dow, and more.
By Kenny Goodrich, Founder of Money Masters MediaEvery day the news reports that the market rose or fell, usually by quoting an index like the S&P 500 or the Nasdaq. But what is an index, really, and why do a handful of them get so much attention? This guide explains what stock market indexes are, how they are built, and how the major ones differ.
What is a stock market index?
A stock market index is a single number that tracks the combined value of a group of stocks. Instead of following thousands of companies one by one, you follow one figure that rises and falls as the group does. Think of it as a way to take the temperature of a slice of the market.
An index is not something you buy directly. It is a measurement, like a scoreboard. What you can buy are funds built to copy an index, which is how indexes grew from a news headline into one of the most common ways people invest.
Why indexes exist
Indexes were not invented to be clever. They solved a few very practical problems, and those reasons still explain why we lean on them today.
A single scoreboard
Before indexes, there was no quick way to say how the market did today. An index turns thousands of separate prices into one number everyone can point to, which is why the news quotes them every day.
A read on the mood
An index gives a fast sense of whether the market rose or fell and by how much. It works as a shorthand for how investors are feeling about company profits and the wider economy.
A way to invest
Indexes also became something you can follow with your money. Funds that copy an index let people own a slice of a whole market at low cost, without picking individual stocks.
How indexes are built
Every index starts with a set of rules. Those rules decide which companies are included, when the list is updated, and how much each company counts. Some indexes are chosen by a committee, while others simply include every company that meets a clear cut-off, such as being listed on a particular exchange.
The list is reviewed on a regular schedule, so companies can be added or removed as they grow, shrink, or change. The most important rule of all is how much weight each company carries, because that decides how much any single stock can move the whole index. That is the next thing worth understanding.
Price weighted vs market cap weighted indexes
Not every company in an index counts equally. The method an index uses to decide who counts for more is called its weighting, and two approaches cover most of what you will see.
Price-weighted
In a price-weighted index, a stock with a higher share price counts for more, no matter how big the company actually is. The Dow Jones Industrial Average works this way, so a single high-priced stock can move it more than a much larger company with a lower price.
Market-cap weighted
In a market-cap weighted index, each company counts in line with its total market value, found by multiplying share price by the number of shares. Most major indexes, including the S&P 500 and the Nasdaq Composite, use this approach, so the largest companies carry the most weight.
Most of the indexes people follow today are market-cap weighted, so the largest companies have an outsized say in how the index moves.
The S&P 500
The S&P 500 tracks around 500 of the largest companies listed in the United States, chosen to represent the broad market. It is market-cap weighted, so the biggest companies carry the most influence, and it spreads across many industries, from technology to health care to energy. For a lot of investors it is the default stand-in for the U.S. stock market.
For a closer look at how it is put together and how people invest in it, see What Is the S&P 500?
The Nasdaq
The word Nasdaq refers to two things: a stock exchange, and the indexes that track the companies listed on it. The best known are the Nasdaq Composite, which follows most of the stocks on the exchange, and the Nasdaq-100, which holds around 100 of the largest non-financial names. Both lean heavily toward technology and growth companies, which is why the Nasdaq can swing more sharply than a broader index.
Our guide on What Is the Nasdaq? goes deeper into the difference between the exchange and the index.
The Dow Jones Industrial Average
The Dow Jones Industrial Average, often just called the Dow, tracks 30 large, well-established U.S. companies. It is one of the oldest and most quoted measures of the market, so it shows up constantly in headlines.
Its quirk is that it is price-weighted, so a company with a higher share price sways the Dow more than one with a lower price, even when the lower-priced company is far larger. That makes the Dow easy to quote but a narrower and less representative gauge than broad, market-cap weighted indexes.
The Russell 2000
The Russell 2000 tracks about 2,000 smaller U.S. companies, so it is widely used as a gauge of how small-cap stocks are doing. Smaller companies often behave differently from the large names that dominate the S&P 500 and the Nasdaq.
They can be more tied to the domestic economy and more sensitive to interest rates, and they tend to move more in both directions. That is why many investors watch the Russell 2000 for a read on that corner of the market.
Total market indexes
Some indexes aim to capture nearly the entire U.S. stock market in one measure, from the largest companies down to much smaller ones, often several thousand in total. Total market indexes try to answer a simple question: how is the whole market doing, not just the big names?
Funds that track them have become a popular way to own a very broad slice of stocks in a single holding, which is one reason total market funds are so common in long-term and retirement accounts.
Why investors follow indexes
Indexes do a lot of quiet work for investors. They serve as a benchmark, a yardstick people use to judge whether their own returns are keeping pace with the market. They also make investing simpler, since a single index fund can hold a broad mix of companies at low cost, which is how many people invest for the long run.
Beyond that, indexes are a fast read on sentiment. A sharp move can hint at how investors feel about growth, profits, inflation, or interest rates, though it is only one signal among many. To put those moves in context, our How Interest Rates Work guide and the Economic Outlook Tracker show what tends to be driving the market beneath the surface, and the Dashboard brings the major indexes together with rates and inflation on one screen.
How this connects to Money Masters tools
Indexes are the headline. These free Money Masters tools and guides help you see what is moving them, and how the major indexes fit with rates, inflation, and the wider economy, all in plain English.
See the indexes in action
You know what the major indexes are. Now watch them move. These free tools track the market, rates, and the economy together, with no jargon and no hype.
Frequently asked questions
What is a stock market index?
A stock market index is a single number that tracks the combined value of a group of stocks, so you can follow a whole slice of the market with one figure instead of thousands of separate prices. It is a measurement, like a scoreboard, not something you buy directly. What you can buy are funds built to copy an index.
What is the difference between the S&P 500, the Nasdaq, and the Dow?
The S&P 500 tracks around 500 large U.S. companies and is treated as a broad benchmark for the market. The Nasdaq indexes lean heavily toward technology and growth companies, so they can swing more sharply. The Dow follows just 30 large companies and is price-weighted, which makes it easy to quote but narrower and less representative than the others.
What does it mean for an index to be market-cap weighted?
In a market-cap weighted index, each company counts in line with its total market value, found by multiplying its share price by the number of shares. That means the largest companies have the most influence on how the index moves. Most major indexes, including the S&P 500 and the Nasdaq Composite, use this approach, while the Dow is price-weighted instead.
Can you invest in an index directly?
Not directly, because an index is a measurement rather than a product. To follow one with your money, you buy a fund built to copy it, such as an index fund or an ETF. That is how indexes grew from a news headline into one of the most common ways people invest.
What is the Russell 2000 used for?
The Russell 2000 tracks about 2,000 smaller U.S. companies, so it is widely used as a gauge of how small-cap stocks are doing. Smaller companies often behave differently from the large names that dominate the S&P 500 and the Nasdaq, tending to be more tied to the domestic economy and more sensitive to interest rates. That is why many investors watch it for a read on that corner of the market.
Educational content only: This guide is for education and general information, not financial, investment, or tax advice, and not a recommendation to buy or sell any index, fund, or security. Index names belong to their respective owners and are mentioned here for education only. Always do your own research and consider speaking with a licensed financial professional before making decisions.
You may also like
Pick one and keep going. No pressure.
Keep learning with Money Masters. Get the free weekly newsletter.