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Table 2.1 The Original Dow Twelve and the Dow Thirty Today
The Dow Jones Industrial Average is one of the benchmarks for the stock market (the Dow Transports date back to 1884 when Charles Dow first created the Dow Jones Railroad Average) and is still mentioned daily when the media discusses day-to-date happenings. For instance, if reporters say, “Stocks were up two hundred points,” or, “The market lost sixty points,” they're likely talking about the industrials. However, the Dow tracks the average performance of just thirty names, and thousands of stocks are trading on the U.S. exchanges.
Key Market Indexes Today
While the Dow tracks the share price action of thirty leading companies and is considered a “cool” market indicator for television, it is not what professional traders rely on day-to-day. Instead, the S&P 500 is an index that includes five hundred of the largest names traded on the U.S. stock exchanges and represents roughly 80 percent of the total value of the U.S. stock market.
The S&P 500 is not only viewed as a barometer for the performance of the U.S. equities market, but it is often used to benchmark the performance of portfolio managers from one year to the next as well. That is, the relative performance of many money managers is measured against the S&P 500. When your livelihood depends on something, you will watch it very closely!
According to Standard & Poor's, the index represents a total of $2.2 trillion in assets today. The companies are included within the index not because they are the largest, but because they are considered leading companies in key industries within the U.S. economy. In addition, although you cannot buy or sell the index itself, there are many ways individual investors can trade the S&P 500, including options on the S&P 500 Index (SPX); S&P 500 Futures (/ES); and the exchange-traded fund (ETF) SPDR 500 Trust (SPY), or Spiders.
With a history dating back to 1923, the S&P 500 is now the most widely watched barometer for the performance of the U.S. equity market. In addition, nearly $8 trillion is benchmarked to its performance. Therefore, when a stock is added or removed from the S&P 500, the adjustment triggers strong buying or selling by the mutual funds and portfolios that attempt to mimic the index's performance. The rise or fall of shares of the individual companies being added to or ousted from the S&P 500 is known as the index effect.
While the S&P 500 covers far more companies and is a more widely used index than the Dow, the methodology used to compute the S&P 500 is different as well. The industrial average is price weighted, and stocks with higher prices within the index exert more influence than low-priced ones. On the other hand, the S&P 500 is a market-value-weighted average.
The top twenty S&P 500 companies account for just 4 percent of the five hundred stocks, but as of this writing, they represent nearly 30 percent of the market value. Table 2.2 shows the largest companies, which include Apple, Microsoft, and Exxon in the top three spots. Because market value is computed as shares outstanding multiplied by share price, it's the biggest companies that dominate the S&P 500 and drive its performance from one day to the next.
Table 2.2 Largest S&P 50 °Companies as of April 29, 2016
Source: CBOE.com
The Dow and S&P 500 are not the only two indexes that track the performance of large-cap stocks. The NASDAQ Composite Index represents share prices of companies that trade on the NASDAQ Stock Market. While the NASDAQ Composite does not have listed options, the NASDAQ 100 Index (.NDX) is a separate index that does have puts and calls linked to its performance. The index includes the top one hundred nonfinancial names that trade on the NASDAQ, and large-cap tech names like Apple, Microsoft, and Oracle dominate the index.
Capitalization, or cap, refers to the size of a publicly traded company and is computed as the number of shares of the company outstanding multiplied by the current market price. So if a company has 10 million shares outstanding and a $20 stock price, the market cap is $200 million.
Beyond the large-cap Dow, S&P 500, and NASDAQ, a number of mid- and small-cap indexes exist as well. There are, in fact, too many to list here. Table 2.3 summarizes some of the more popular ones. Note that not all of them have listed futures or options contracts.
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