🎯 In 30 seconds: An index is a scorecard for a group of stocks. When the news says "the market was up 1%", it usually means the S&P 500 rose 1%. Each index picks different stocks and weights them differently: the S&P 500 and Nasdaq indexes weight by company size, the Dow by share price. That is why they can disagree on the same day. You cannot buy an index directly, but index funds copy them.
What an index is
A market index tracks the performance of a basket of stocks that represents a market or a slice of one. It is a single number that rises and falls as the stocks in the basket rise and fall.
Indexes do three jobs:
- A summary. One number that tells you how a whole market did today.
- A benchmark. A yardstick to judge your own results. If your trading made 6% in a year when the S&P 500 made 15%, a plain index fund would have done better.
- A product. Index funds and ETFs hold the same stocks in the same weights, so you can own the whole basket in one purchase. See ETFs and index funds.
Every index needs two rules: which stocks are in, and how much each one counts. The second rule is called weighting, and it changes everything.
Three ways to weight a basket
Market-cap weighted. Each company counts in proportion to its market value (share price times shares). Big companies move the index more. Most major indexes use this, often counting only the shares available to the public (the "float").
Price weighted. Each stock counts in proportion to its share price, regardless of company size. For the same percentage move, a $300 stock moves the index fifteen times as much as a $20 stock. The Dow works this way.
Equal weighted. Every stock counts the same. Some index providers publish equal-weight versions of the big indexes.
Worked example: one day, three answers
A hypothetical index of three companies. Same stocks, same day, three weighting rules.
| Company | Price | Shares | Market cap | Cap weight | Price weight | Today |
|---|---|---|---|---|---|---|
| A | $300 | 1 billion | $300B | 30% | 81.1% | +10% |
| B | $50 | 10 billion | $500B | 50% | 13.5% | −2% |
| C | $20 | 10 billion | $200B | 20% | 5.4% | 0% |
Price weights come from each price divided by the sum of prices ($300 + $50 + $20 = $370). Now compute the index move each way:
| Cap weighted: 30% x 10% + 50% x (−2%) + 20% x 0% | +2.0% |
| Price weighted: prices sum $370 before, $330 + $49 + $20 = $399 after | +7.8% |
| Equal weighted: (10% − 2% + 0%) / 3 | +2.7% |
Same market, same day: up 2.0%, 7.8% or 2.7% depending on the rule. In the price-weighted version, Company A dominates just because its share price is high, even though B is the biggest business.
The S&P 500
The S&P 500 is the most widely used gauge of large US companies. It holds 500 leading companies listed on the NYSE or Nasdaq and covers about 75% of the value of US stocks. A committee at S&P Dow Jones Indices chooses the members using rules on size, profitability, trading volume and other criteria, so it is not simply the 500 largest.
It is weighted by float-adjusted market cap, so the largest companies have the biggest effect. In recent years a handful of very large technology-related companies have made up a large share of the index, which means "the market" can rise or fall mostly because of a few names.
The standard S&P 500 number you see quoted is a price index: it does not include dividends. A total return version adds dividends back in, and over long periods the gap is large.
The Dow Jones Industrial Average
The Dow is the oldest well-known US index: 30 large "blue chip" companies picked by a committee. Despite the name, most are no longer industrial companies.
It is price weighted. The index equals the sum of the 30 share prices divided by a number called the divisor. The divisor is adjusted whenever a company splits its stock or the list changes, so the index does not jump for reasons that have nothing to do with the market.
Using the example above: with a divisor of 0.37, the three prices summing to $370 give an index of 1,000. If Company A then splits 3-for-1, its price drops from $300 to $100 and the sum falls to $170. The divisor is cut to 0.17, so the index stays at 1,000. The catch: after the split, A counts a third as much as before, even though nothing about the business changed. That quirk is the main criticism of price weighting.
The Nasdaq Composite and the Nasdaq-100
The Nasdaq Composite includes nearly all common-type stocks listed on the Nasdaq Stock Market, domestic and international, weighted by market cap. It holds thousands of companies and leans heavily toward technology.
The Nasdaq-100 holds 100 of the largest non-financial companies listed on Nasdaq. It uses a "modified" market-cap weighting with caps. When the rules are triggered (for example, if any company's weight goes above 24%), weights are adjusted so no company is above 20%, and if the members weighing over 4.5% each add up to 48% or more, that group is cut back to 40% in total. These caps exist because a few giant companies would otherwise dominate the index. Many popular ETFs track it.
The Russell 2000 and small companies
FTSE Russell builds the Russell US indexes by ranking US stocks by market value. The Russell 3000 covers the broad market. The Russell 1000 is the largest 1,000 of those, and the Russell 2000 is the remaining 2,000 smaller companies. It is the standard benchmark for US small caps.
Membership is reset in a process called reconstitution. FTSE Russell has announced that this moves from once a year to twice a year starting in 2026. Small companies tend to swing more than large ones and are more sensitive to borrowing costs, so the Russell 2000 often moves differently from the S&P 500. See Growth vs value, and company size.
| Index | What is in it | Weighting |
|---|---|---|
| S&P 500 | 500 leading large US companies, chosen by committee | Float-adjusted market cap |
| Dow Jones Industrial Average | 30 blue-chip US companies, chosen by committee | Share price |
| Nasdaq Composite | Nearly all common-type stocks listed on Nasdaq | Market cap |
| Nasdaq-100 | 100 of the largest non-financial Nasdaq-listed companies | Modified market cap, with caps |
| Russell 2000 | 2,000 smaller US companies (the bottom of the Russell 3000) | Market cap |
Points vs percent: reading the headline
News often reports moves in points: "the Dow fell 500 points". Points alone mean little, because the size of a point depends on the index level.
| Index at 40,000 falls 500 points | −1.25% |
| Index at 4,000 falls 500 points | −12.5% |
| Index at 6,000 rises 60 points | +1.0% |
Percent change = points change / previous close x 100. Always convert to percent before you compare days, indexes or decades. A 1% day for the S&P 500 is normal. A 3% day is unusual. A fall of 7% or more in the S&P 500 during the day triggers a market-wide trading pause, covered in The rules every trader runs into.
What this means for a trader
- Most individual stocks move partly with the market. On a day the S&P 500 drops 2%, a good chart setup can fail for reasons that have nothing to do with the company.
- Check the index trend before taking a trade. Many traders avoid new long positions when the major indexes are in a downtrend. See Trends and Bull and bear markets.
- A benchmark keeps you honest. If your trading does not beat a low-cost index fund after costs and taxes, the index fund was the better trade.
Try it
Open the index dashboard at the end of each trading day for one week. Write down the percent change of the S&P 500, Dow, Nasdaq Composite and Russell 2000. At the end of the week, find the day they disagreed most and work out which kind of stocks (large or small, technology or not) explain the difference.
- How is the Dow weighted, and how is the S&P 500 weighted? Answer: The Dow is weighted by share price. The S&P 500 is weighted by float-adjusted market cap.
- Does the standard S&P 500 number you see quoted include dividends? Answer: No. It is a price index. A separate total return version adds dividends back in.
- An index at 4,000 falls 500 points. What is that in percent? Answer: A 12.5% fall (500 / 4,000 x 100). The same 500 points from 40,000 would be only 1.25%.
- You mostly hold small companies. Which index should you compare your results with? Answer: The Russell 2000, the standard benchmark for US small caps, not the Dow.