The Dow is up. But recently the Dow has been mostly down. So has the S&P 500, the Russell 2000, the New York Stock Exchange index, and the NASDAQ Composite Index. All of these are stock indices, a measure of average stock prices. Simply put, indices are numeric gauges of broad market performance. A single number is used to represent the relative price level of a group of individual stocks.
Indices exist for everything: from the price of stocks in the U.S. to the price of stocks in every country in which there is a stock exchange, as well as indices for other types of investments such as bonds and real estate. If you can imagine a class of assets, then you can bet there is already an index that tracks its performance.
Stock indices are used as a shorthand method of talking about prices for a segment of the stock market. Besides serving as a shorthand measure of prices for groups of stocks, stock indexes are also used as benchmarks against which the performance of investment managers is measured. For example, many portfolio managers are evaluated according to their returns relative to the appropriate indices.
A third, and very popular, use of indices is as a way to invest. Index investing refers to the practice of buying all of the stocks in an index, often through a mutual fund set up for that purpose, rather than picking individual stocks.
Take the most widely noted index -- the Dow (technically, the Dow Jones Industrial Average). The Dow Jones Industrial Average consists of stocks that are not especially industrial in nature. The Dow includes financial, food, technology, retail, heavy equipment, oil, chemical, pharmaceutical, consumer goods, and entertainment companies. The most striking similarity of the stocks in the Dow is their huge size; each company has sales of over $7 billion per year.
Each of the indices has its peculiarities, and the best index for you to use to track the markets and your investing depends on the stocks you are interested in and the markets in which you want to invest.
To hear Professor Marvin Zonis, from the University of Chicago Graduate School of Business, talk about stock indices, check out our One Minute MBA video clip. Just click the appropriate connection speed in the video box on the right column of this page.