Stock Market Indices and How They Can Dictate Your Stock Buys and Sells

Buy, Sell, Low, High, Bears, Bulls - Easy right? Not so much… As Monica from Friends quickly learned, the stock market isn't about picking fun letters and hoping for the best! One of the many things a novice investor should have a grasp on to better understand the market is the main stock market indices and what they mean. We are going to focus on the main five indices that make up the "market" as it's commonly referred to.

The S&P 500: If you plan to stick with one index to follow - this is the one as its performance showcases the most accurate portrayal of the movements of the entire stock market. The Standard & Poors 500 includes the most frequently traded stocks in the US and represents around 70% of the total value of the US stock markets. This index is market weighted, meaning that every stock is represented in proportion to its total market capitalization. The S&P 500 is commonly viewed as a better measure than an index such as the Dow, which is weighted based on price.

The Wilshire 5000 Total Market Index: The Wilshire 5000 includes all publicly traded companies headquartered in the US with readily available price data. This index includes stocks from every industry, making it a very comprehensive picture of the market as a whole. Like the S&P 500, The Wilshire is market weighted and is an accurate picture of the total market's movement, although it's less popular than the S&P.

The Dow Jones Industrial Average: The Dow Jones Industrial Average, also known as the Dow, is perhaps the most well-known stock market index in the world. It is also one of the oldest. The Dow is a price weighted index, meaning stocks influence the index based on share price - the higher the share price, the greater influence that stock's performance has on the index. It is calculated, in simple terms, by adding the per share price of each company within the index and dividing this sum by the number of companies - giving you an average. The actual calculation is much more complex, but this is the basic idea.

Nasdaq Composite Index: Another market weighted index, the Nasdaq, is very commonly known even among the most inexperienced investors. The Nasdaq includes over 3,000 companies, a large portion of which are technology companies. It's not exclusive to the US and includes companies of all sizes and market capitalizations. The Nasdaq is often followed by investors with an interest in growth companies as well as technology, as it has been known to be an accurate indicator of these industries' performance.

The Russell 3000 Index: The Russell 3000 measures the performance of 3,000 publicly held US companies based on total market capitalization, and represents approximately 98% of the US stock market. The Russell 2000 is a market weighted index of the 2,000 smallest stocks within the Russell 3000. Investors interested in small-cap stocks often follow the Russell 2000. Neither the Russell 3000 or 2000 is dominated by any single industry.

Stock Market indices can often be confusing, with different types of stocks, companies and measurements, but investors with a strategy - for example, interest in small cap stocks or technology start-ups - find these indices helpful in identifying market shifts within a specific sector. On the flip side, investors interested in the market as a whole find the S&P and Wilshire indices helpful in identifying investor sentiments and major upswings (or downward trends). Understanding each index and what it means will make you a better informed investor, which will lead to a better outcome for your stock choices!