Stock Market 101
From the outside looking in, it’s easy to say that navigating the stock market could appear a daunting task. It could easily be intimidating to the novice. But that’s only the case when you don’t have the proper knowledge to make an informed decision on when and where to invest your money. When you know the terms of the market and have an inkling of what they mean, it makes your stock market venture all the easier. If you’ve watched the evening news, then surely you’ve heard terms tossed around like the DOW, S & P and NASDAQ!
But what do these terms mean? And what do they tell us?
Here we’ll walk you through a sort of “Stock Market 101” to help make investing in the market far less intimidating and much easier to understand!
The terms you’ve heard before, such as the Dow Jones Industrial Average, S&P 500 and NASDAQ are all examples of a “market index.” An index provides a summary of the overall market by tracking some of the top stocks within that market. It also gives a representative snapshot that shows the direction of the overall market and how the market is performing. Is the Dow up or down? It is a group of numbers derived from the price movements of certain stocks. This number, up or down, gives you an idea of how the index is performing. Even though they are not perfect, indices show trends and changes in investing patterns. They provide a yardstick for comparison, and they also provide, as we said, a snapshot. The three listed here are the most popular market indices. We’ll take a closer look at these three, provide a bit of history and find out what they mean and how they operate.
The Dow Jones Industrial Average (DJIA) is commonly referred to as the Dow.
This index is named after Charles Dow, editor of the Wall Street Journal and co-founder with statistician Edward Jones of Dow Jones & Company, who first calculated it on May 26, 1896. Dow averaged the stock prices of the top 12 publicly traded companies. By doing this, he found that he could trace the movement of the overall stock market, including the general movement of stocks that were not included in the financial calculations. S&P Dow Jones Indices currently maintains and publishes the Dow, among other financial indices.
Today, the Dow tracks the 30 largest, richest and most heavily traded U.S. companies; among them are the large, “blue chip” companies such as Johnson & Johnson, McDonald’s, General Electric, Microsoft and Coca-Cola. Although the companies within the Dow Jones represent only one-fourth of all stocks, the Dow, nonetheless, is widely regarded as the leading indicator of overall market health. The Dow is the second-oldest and most widely known index; the Dow Jones Transportation Index, also created by Charles Dow, is the oldest.
The S&P 500®
Standard and Poor’s Financial Services, LLP, or S&P, is a division of McGraw Hill Financial that publishes statistical reports. Its roots go back to 1868, when Henry Varnum Poor began publishing information about the state of U. S. railroads. In 1941, Poor’s Publishing merged with the Standard Statistics Bureau to form Standard & Poor’s Corp.
This index tracks 500 large U.S. companies and is the most frequently used by financial professionals. The stocks in the S&P 500 represent roughly 75 percent of all the stocks that are publicly traded, so in that regard, it is much closer to representing the true market than the Dow.
This index is the most complex of the three and refers to two different things. NASDAQ, the National Association of Securities Dealers Automated Quotations system, was the first electronic exchange, called the NASDAQ Exchange, where investors could buy and sell stock. The National Association of Securities Dealers went live on February 8, 1971, providing investors the ability to purchase stocks on a fast, computerized system that eliminated the inefficiency of in-person transactions. Today, thanks to its merger in 2008 with OMX ABO, a Stockholm-based exchange operator, it’s the largest electronic equities exchange in the U.S.
However, when you hear people say “the NASDAQ is up today,” they are referring to the NASDAQ Composite Index, which is completely different from the NASDAQ Exchange. The NASDAQ Composite Index is a statistical measure of a portion of the market and tracks nearly 4,000 stocks, all of which are traded on the NASDAQ Exchange. Stocks traded on the NASDAQ Exchange encompass tech companies, such as Apple and Google, plus companies, airline, pharmaceutical, healthcare, Starbucks and Amazon. NASDAQ Composite has become popular because it is commonly accepted as an indicator of how tech-sector and innovative companies, both big and small, are faring. It is not designed to represent the entire market, but it does provide a good idea of where technology investors are going.
Now, armed with your bundle of stock prospectuses, you’re a little closer to creating your future!
Sources: beginnersinvest.about.com, budgeting.about.com, investopedia.com, nasdaqomx.com.