A stock index is a group of stocks chosen to represent how a part of the market is performing

An index is not something you own or trade directly. It is a measurement tool — like a thermometer for the market. An index tracks the price movement of a selected group of stocks, and the number you see reported (like "the S&P 500 is up 2% today") tells you whether those stocks, as a group, are going up or down.

The stocks in an index are chosen by a company that maintains the index. That company decides which stocks belong, how much weight each one gets in the calculation, and when to swap one stock out for another. Different indexes track different parts of the market — some follow large companies, some follow small ones, some follow a single industry, and some follow stocks in a single country.

When you hear someone say "the market is up," they are usually referring to one of the major indexes. But the market is not a single thing — it is thousands of stocks moving in different directions at the same time. An index is a shorthand way to talk about what a particular group of them is doing.

Key Takeaways

  • An index measures the performance of a chosen group of stocks, not a thing you can buy or sell directly.
  • Different indexes track different parts of the market — large companies, small companies, specific industries, or specific countries.
  • The company that maintains an index decides which stocks go in it and how much each one counts toward the index number.
  • You can invest in an index indirectly by buying an index fund or exchange-traded fund (ETF) that holds all or most of the stocks in that index.

The three largest U.S. stock indexes and what they track

The S&P 500 tracks 500 large U.S. companies. It is maintained by Standard & Poor's, a financial data company. The S&P 500 is the most widely used measure of overall U.S. stock market health because it covers a broad range of industries and company sizes within the "large company" category.

The Dow Jones Industrial Average (often called "the Dow") tracks 30 very large U.S. companies. It is the oldest major index in the United States, started in 1896. Because it includes only 30 stocks, it is narrower than the S&P 500, but those 30 companies are among the most established in the country.

The Nasdaq Composite tracks more than 3,000 stocks listed on the Nasdaq exchange. It includes many technology and growth-focused companies, though it also includes companies from other industries. Because it is so broad, it moves differently than the S&P 500 or the Dow on any given day.

How index numbers are calculated

An index number is calculated by adding up the prices of the stocks in it, then adjusting that total using a formula. The formula depends on how the index is constructed. Most major indexes use one of two methods: price-weighted or market-cap-weighted.

In a price-weighted index, stocks with higher prices have more influence on the index number. The Dow Jones Industrial Average uses this method. If one of the 30 companies in the Dow has a stock price of $300 per share and another has a price of $100 per share, the $300 stock pulls the index number up or down more when its price moves.

In a market-cap-weighted index, the total value of each company (its market capitalization, or the stock price multiplied by the number of shares outstanding) determines its influence. The S&P 500 and Nasdaq use this method. A very large company like Apple or Microsoft has more weight in the index than a smaller company, even if its stock price per share is lower. This method is considered more representative of overall market value because it reflects the actual size of each company.

Why indexes matter to investors

An index serves as a benchmark — a standard you can use to measure how your own investments are doing. If you own a mix of stocks and the S&P 500 goes up 10% in a year but your portfolio only goes up 5%, you know your picks underperformed the broader market. If your portfolio goes up 12%, you outperformed it.

Indexes also make it easier to invest in the market without picking individual stocks. Instead of researching and buying 500 different companies, you can buy a single index fund or ETF that holds all 500 stocks in the S&P 500. The fund's price moves with the index, so you get the same performance as the index itself (minus a small fee).

Financial professionals also use indexes to understand market trends and economic health. A sustained rise in an index suggests investor confidence and economic growth. A sustained fall suggests concern or economic slowdown. Indexes that track specific industries or company sizes help identify which parts of the market are doing well and which are struggling.

Other indexes beyond the major three

Hundreds of indexes exist beyond the S&P 500, Dow, and Nasdaq. The Russell 2000 tracks 2,000 small U.S. companies, so it moves differently than the large-company indexes. The Nasdaq 100 tracks 100 of the largest companies on the Nasdaq exchange, mostly technology firms. The Wilshire 5000 attempts to track the entire U.S. stock market by including nearly every publicly traded U.S. company.

International indexes track stocks in other countries. The FTSE 100 tracks large U.K. companies. The DAX tracks large German companies. The Nikkei 225 tracks large Japanese companies. These indexes help investors understand how markets outside the United States are performing and provide a way to invest in foreign stocks.

Sector indexes track specific industries. The Nasdaq-100 Information Technology Index tracks technology stocks. The S&P 500 Energy Index tracks energy companies within the S&P 500. These narrower indexes help investors see which industries are gaining or losing value.

How index composition changes over time

The stocks in an index are not permanent. The company that maintains the index reviews its holdings regularly and removes stocks that no longer meet the criteria, replacing them with stocks that do. A company might be removed because it has shrunk and no longer qualifies as "large," because it has gone bankrupt, or because it has been acquired by another company.

When a major company is added to or removed from an index, it can affect the index's value. If a stock is added to the S&P 500, many index funds that track the S&P 500 will buy shares of that stock to stay aligned with the index. This sudden buying can push the stock's price up. The reverse happens when a stock is removed.

Index changes are announced in advance, usually weeks before they take effect. This gives investors time to prepare. You can find announcements of index changes on the websites of the companies that maintain the indexes — S&P Global for the S&P 500, CME Group for the Dow, and Nasdaq for the Nasdaq indexes.

Frequently Asked Questions

Can I buy shares in an index directly?

No. An index is a measurement, not an investment product. You cannot buy "the S&P 500" the way you buy a stock. However, you can buy an index fund or ETF that holds the stocks in the index, which lets you invest in all those companies with a single purchase.

Why do different indexes show different market performance on the same day?

Different indexes track different groups of stocks. The Nasdaq includes many technology companies, so on a day when tech stocks fall but other industries rise, the Nasdaq might be down while the S&P 500 is up. The Dow's smaller number of stocks means a single large company's movement has more impact on its daily change.

Is the index number the actual price of something?

Not exactly. The index number is a calculated value based on the stocks in the index and the formula used to weight them. The S&P 500 index number might be 4,500, but that is not a price you can buy or sell. Index funds and ETFs that track the index have their own prices, which move in line with the index.

How often do index numbers change?

Index numbers are calculated continuously during market hours (9:30 a.m. to 4:00 p.m. Eastern time on weekdays when the U.S. stock market is open). As individual stock prices move, the index number updates. You will see the index number reported throughout the day on financial websites and news outlets.

What is the difference between an index and a mutual fund?

An index is a measurement tool. A mutual fund is an investment product that pools money from many investors to buy stocks or other securities. An index fund is a type of mutual fund designed to track a specific index by holding the same stocks in the same proportions. Not all mutual funds track indexes — some are actively managed, meaning a fund manager picks stocks trying to beat the index.