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What’s the Nasdaq? All About Indexes

January 05, 2018

  • The Nasdaq index reached a record high this week, closing above 7,000
  • The Nasdaq is often used as gauge of tech sector strength
  • Indexes of various kinds, including the Dow and S&P 500, are currently in record territory
3 min read

It’s a new year, and the stock market continues to roar ahead.

An index called the Nasdaq reached a milestone this week, closing above 7,000 points for the first time in its history.

The Nasdaq is among the most important stock indexes in the U.S., along with the Dow Jones Industrial Average, S&P 500, and the Russell 2000, which measures the stocks of smaller companies.

Over the past year, numerous stock indexes have reached record highs. The reasons for the increases include an economic recovery that continues to gain steam in the U.S. and abroad, low inflation and low interest rates, and strong employment numbers.

A recent tax overhaul passed by Congress in the U.S., whose centerpiece includes major tax cuts for corporations, could also be contributing to the increases, according to some experts.

The stocks of five companies accounted for most of the 1,000 point increase for the Nasdaq over the last eight months, according to reports. Those companies include Amazon, Apple and Facebook.

Companies contributing biggest point gains to the Nasdaq since April, 2017:

Source:  Wall Street Journal

What is the Nasdaq anyway?

The Nasdaq is an index with a high concentration of technology stocks. It consists of the stocks of more than 3,200 companies. In addition to Amazon, Apple, and Facebook, other well-known tech names include Google’s parent company Alphabet, computer network router maker Cisco Systems, and computer software and services giant IBM.

The Nasdaq is different from indexes such as the Dow Jones Industrial Average (the Dow, or DJIA) and the S&P 500. The Dow, one of the oldest indexes in the U.S. created in 1896, is composed of 30 of the largest and most successful companies in the world, including names such as financial company American Express, machinery manufacturer Caterpillar and consumer goods company Procter & Gamble.

Fun fact: The “industrial” part of the DJIA is a holdover from the era when most of the companies that made up the index were manufacturers. These companies have been replaced over time with businesses that don’t necessarily make things in factories. (The only remaining original company is General Electric.)

Similarly, the S&P 500 index, as its name implies, is made up of the 500 largest companies in the U.S., including names such as insurance company Allstate, home construction and refurbishing company Home Depot, and Walmart, the largest retailer in the world. The Russell 2000 consists of smaller companies, including 1-800 Flowers, recreational products company Johnson Outdoors, and the drug-maker Sucampo Pharmaceuticals.

Sometimes big companies can appear in multiple indexes simultaneously. For example, Apple and Microsoft are both in the Dow, the S&P 500 and the Nasdaq.

Here’s something else to keep in mind: While the Nasdaq is known as a technology index–it became extremely popular in the Dotcom era of the 1990s–the number of tech companies in it has decreased over time, and now only make up 45% of the index, according to the Wall Street Journal.

So while most people associate technology stocks with the Nasdaq, the index also holds the stock of biotech and pharmaceutical companies, as well as business services, insurance, and telecommunications companies, among others.

The Nasdaq is an index with a high concentration of technology stocks

Nasdaq composite increases since January, 2017:

Source: Wall Street Journal

How does an index work?

In short, an index is a grouping of company stocks that measures changes in the broader stock market, or a sector of the stock market.

Generally speaking, each company in an index is assigned a weight in a mathematical calculation that creates the final index number. That weight can be based on the stock share price, as it is with the Dow. It can also be based on market cap, a reflection of a company’s value, which is how the S&P is calculated. Some indexes might also combine both to assign the weight. As individual share prices or market caps move up and down, those changes affect the total point value of the index.

Typically exchanges like the Dow or S&P are taken as a gauge of the entire stock market. The Nasdaq is frequently used to measure change in an important sector of the stock market, which is technology.

The difference between indexes and exchanges

It’s important to keep in mind that indexes are not the same thing as exchanges. Exchanges are the actual places where stocks are bought and sold. One of the most famous exchanges, called the New York Stock Exchange (NYSE), is headquartered on Wall Street, in New York.

The Nasdaq, located in Midtown Manhattan, is also an exchange where traders buy and sell the stocks that make up the Nasdaq index. The index is a purely electronic exchange. The NYSE combines an electronic exchange with live people who help execute stock trades.

A good year for other indexes too

This has been a record-breaking 12 months for numerous indexes. The Dow also closed in on the 25,000 mark as of January 4, 2018, after gaining more than 5,000 points in a single year.

Similarly, The S&P 500 also had a big year, achieving four 100-point increases since the start of 2017, according to Bloomberg. It is at 2,724, as of January 4, 2018.

By Jeremy Quittner
Jeremy Quittner is the financial writer for Stash.

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