How Stock Market Indices Work: S&P 500, Nasdaq and the Dow

Educational content only. This explainer covers how stock market indices are built. It contains no forecasts or recommendations and is not financial advice.

When the news says "stocks rose today", it almost always means that a stock market index rose. An index is a single number that summarises the prices of a group of shares. Different indices pick different companies and weight them in different ways, which is why they do not always move together.

The main US indices

• S&P 500 tracks around 500 large US companies chosen by a committee at S&P Dow Jones Indices. It is weighted by market value, so the largest companies have the biggest influence. It is the most common benchmark for "the US stock market".
• Nasdaq Composite includes almost all companies listed on the Nasdaq exchange and leans heavily towards technology. The Nasdaq-100 is a narrower index of the 100 largest non-financial companies listed there.
• Dow Jones Industrial Average follows just 30 large US companies and is weighted by share price rather than company size, an old method that gives more influence to companies with higher-priced shares.

Outside the US, widely followed indices include the FTSE 100 in London, the DAX in Frankfurt, the Euro Stoxx 50 for the euro area, the Nikkei 225 in Tokyo and the Hang Seng in Hong Kong.

How weighting works

Most modern indices are market-capitalisation weighted: each company counts in proportion to its total market value, usually adjusted to include only shares that are freely tradable. A 1% move in one of the biggest companies therefore moves the index far more than a 1% move in a small one. When a few very large companies dominate an index, it can rise or fall mainly because of them, even if most other shares move the other way.

Indices you can actually buy

You cannot buy an index directly, but index funds and exchange-traded funds (ETFs) aim to track one at low cost. For example, the Vanguard Total Stock Market ETF (VTI), shown in the Market Plus quotes strip, tracks an index of almost the entire US stock market, from the largest companies to small ones. Tracking funds still carry market risk: when the index falls, so does the fund.

What moves an index

Company earnings

Over the long run, share prices follow companies' profits. Quarterly earnings seasons, and especially guidance about future profits, are major events for index levels.

Interest rates

Higher rates make borrowing more expensive and make bonds more competitive with shares, which tends to weigh on valuations, especially for fast-growing companies. Lower rates usually have the opposite effect.

Economic data and sentiment

Growth, jobs and inflation figures shape expectations for both profits and rates. Fear and optimism matter too: volatility measures such as the VIX are often called the market's "fear gauge".

Price index or total return?

Headline index levels usually ignore dividends. A total return version assumes dividends are reinvested, and over many years the difference becomes large. When comparing an investment with an index, make sure you compare like with like.

An index is a simple number with a lot of design choices behind it. Knowing which companies it includes and how they are weighted tells you what a "record high" or a "sell-off" really means.