Using Stock Indexes to Measure Performance

Instructor: Kaitlin Oglesby
Stock indexes provide an easy way to get a snapshot view of how the economy is doing. In this lesson, we learn about different indexes as well as bull and bear markets.

What Is a Stock Index?

Any time you turn on the news, there is someone talking about the stock market. Of course, they never refer to it as a collection of the whole or even as how specific stocks are doing. Instead, pundits and news reporters make reference to indexes that seem to explain everything. A stock index is a way of measuring the performance of multiple stocks as one simple number. Often, these are weighted calculations that take into account the gains and losses of the component stocks, as well as some way of seeing how much of each stock was traded. In other words, there is a lot of information in that relatively short number.

Examples

By far the most famous stock index is the Dow Jones Industrial Average. This stock index tracks thirty companies that are deemed by the Dow Jones company to be especially important to the economy. Companies like 3M, IBM, and American Express are part of the Dow Jones Industrial Average, or DJIA. However, it is not the only important index. There is also NASDAQ, a stock index that describes all the action on the NASDAQ stock exchange. Originally, the NASDAQ was set up for tech companies, but now many other firms trade on it. Finally, the Standard and Poor's 500, often called the S&P 500, includes 500 stocks that are particularly noteworthy according to Standard and Poor's.

Of course, there are plenty of other indexes out there. The stock markets of London and Paris are often described by the FTSE 100 or the CAC 40, respectively. Further, some industry-specific indexes exist to track that sector.

Measuring a Specific Security

Stock indexes can be quite valuable when tracking how a specific company or mutual fund is performing. This is because a stock index provides a measure of how the economy is doing, which we'll see more about in a minute. When tracking a specific stock, it shows how the company is performing with respect to the other companies in the economy. Meanwhile, when comparing a mutual fund to a stock index, we get a measure of how well the fund managers are doing their job of picking the best securities possible.

Measuring the Economy

As I alluded to earlier, stock indexes are also valuable for measuring the entire economy. Because the numbers used to describe the major stock indexes are relatively low, they provide a useful way of describing the movements of a much larger economy. For example, we may describe the market as being up or down a few hundred points, when in reality tens billions of dollars have exchanged hands.

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