A stock index is a tool that lets investors follow the rise and fall of share prices in a particular segment of the stock market or the entire market. In the United States, a common stock index follows the performance of the ordinary -- or common -- shares that come with voting rights. Since their introduction in the late 19th century, the number of common stock indexes and their uses have increased.
Charles H. Dow devised the first indexes of common stocks as a means to show the direction of the broader stock market. He began the average of U.S. transportation stocks in 1884, mostly with railroad stocks, according to the S&P Dow Jones Company. On May 26, 1896, he began his average of 12 industrial stocks, and he began his utility average in 1929. More than 100 years later, the Dow Jones Industrial Average, or DJIA, includes 30 stocks.
Many other indexes share the financial spotlight with the Dow indexes today. The S&P 500 Index, dating from 1957, follows a larger portfolio of 500 U.S. stocks. Other broader market indexes include the the NYSE Composite Index, tracking all stocks on the New York Stock Exchange, and the Wilshire 5000 Total Market Index, tracking all stocks on U.S. markets. The Nasdaq 100 Index follows major U.S. and international securities on the Nasdaq exchange, and international indexes track foreign stocks, including the CAC 40 in France and the Nikkei in Japan.
The first Dow Jones averages were calculated by adding together the stock prices and dividing by the number of stocks. Now the DJIA uses a divisor adjusted for stock splits, according to the S&P Dow Jones company. This index is not weighted for market capitalization, or the number of shares times price. Many other indexes are weighted for capitalization, including the S&P 500 Index, the Wilshire 5000 Total Market Index, the Russell 2000 Index and the NYSE Composite Index.
Major media report the common stock indexes daily or hourly, and some show the numbers all day long on a news ticker or flash them intermittently on the screen. Investors use the various stock indexes as a measuring stick or benchmark to compare their investments to similar stocks. Ordinary investors and economists also use the indexes to gauge the health of the overall economy or particular segments, such as technology.
A single stock or sector can skew indexes weighted by market capitalization, such as the S&P 500, according to "U.S. News Money." While avoiding this problem, the Dow Jones Industrial Average excludes major players in the modern economy, including technology companies Apple and Google. Using indexes to predict the direction of the economy is risky, according to S&P Dow Jones. Although sometimes the stock market anticipates economic changes by six months or more, this is not always the case.
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