Measuring Market Performance
Market indices track the performance of a group of stocks, giving us a snapshot of overall market health. When people say "the market is up today," they're usually referring to an index. Understanding indices is fundamental to investing—they serve as benchmarks for your portfolio, indicators of economic health, and even tradable assets themselves.
What is a Market Index?
📊 Definition
A market index is a statistical measure that tracks the performance of a specific group of stocks. It's calculated from the prices of its component stocks and expressed as a single number, making it easy to see how a market segment is performing over time.
Major US Indices
📊 S&P 500
500 largest US companies by market cap
The gold standard benchmark for the US stock market. Covers approximately 80% of total US market capitalization.
Key Details:
- Weighting: Market-cap weighted (larger companies = bigger impact)
- Selection: Committee-selected, not purely mechanical
- Requirements: US company, $14.6B+ market cap, profitable, adequate liquidity
- Rebalancing: Quarterly
Top 10 Holdings (changes over time):
| Apple | ~7% |
| Microsoft | ~7% |
| NVIDIA | ~6% |
| Amazon | ~3.5% |
| Meta | ~2.5% |
| Alphabet (GOOGL + GOOG) | ~4% |
| Berkshire Hathaway | ~1.7% |
| Tesla | ~1.5% |
Note: Top 10 stocks represent ~30%+ of the index—concentration risk.
Historical returns: ~10% average annual return since inception (1957)
📈 Dow Jones Industrial Average (DJIA)
30 large, well-established US companies
The oldest and most famous index (since 1896). Named after Charles Dow and Edward Jones, founders of the Wall Street Journal.
Key Details:
- Weighting: Price-weighted (higher stock price = bigger impact)
- Selection: Subjective, chosen by WSJ editors
- Only 30 stocks: Less diversified, less representative
- No tech focus: More traditional industries
Current Components Include:
Apple, Microsoft, UnitedHealth, Goldman Sachs, Home Depot, McDonald's, Caterpillar, Boeing, Visa, Johnson & Johnson
⚠️ Price Weighting Problem
Because the Dow is price-weighted, a $500 stock has 5x the influence of a $100 stock, regardless of company size. This makes it a less accurate representation of the overall market than the S&P 500.
💻 NASDAQ Composite
3,000+ stocks listed on NASDAQ exchange
Includes all domestic and international companies listed on NASDAQ. Heavy technology concentration makes it more volatile than S&P 500.
Key Details:
- Weighting: Market-cap weighted
- Composition: ~50% technology stocks
- Volatility: Higher than S&P 500
- Growth-oriented: More growth stocks, fewer value stocks
💻 NASDAQ-100
100 largest non-financial NASDAQ companies
More focused index excluding financial companies. What QQQ ETF tracks.
Top holdings: Apple, Microsoft, Amazon, NVIDIA, Meta, Alphabet, Tesla, Broadcom
Other Important US Indices
📈 Russell 2000
Tracks 2,000 small-cap US companies. Best benchmark for small-cap performance. More volatile than large-cap indices but often leads recoveries.
ETF: IWM
📊 Russell 3000
Covers 3,000 stocks representing ~98% of the investable US market. Combines large, mid, and small caps.
📈 S&P MidCap 400
Tracks 400 mid-cap companies. Sweet spot between stability and growth.
ETF: MDY
📊 Wilshire 5000
Aims to track ALL publicly traded US stocks. Broadest US market measure.
😨 VIX (Volatility Index)
"Fear gauge" that measures expected S&P 500 volatility from options prices. High VIX = fear/uncertainty. Low VIX = complacency.
- VIX 12-15: Low volatility, calm markets
- VIX 20-25: Elevated uncertainty
- VIX 30+: High fear, potential market stress
- VIX 40+: Extreme fear (major crashes)
How Indices Are Calculated
⚖️ Market-Cap Weighted (Most Common)
Used by: S&P 500, NASDAQ, most modern indices
How it works: Each stock's weight is proportional to its market capitalization.
Formula: (Stock's Market Cap ÷ Total Index Market Cap) × Index Level
💡 Example
If Apple has a $3 trillion market cap and the S&P 500 total market cap is $40 trillion:
Apple's weight = $3T ÷ $40T = 7.5%
If Apple moves 1%, it impacts the index by 0.075% (1% × 7.5%)
Pros: Represents economic reality, larger companies matter more
Cons: Can become top-heavy (top stocks dominate)
💵 Price Weighted
Used by: Dow Jones Industrial Average, Nikkei 225
How it works: Each stock's weight is proportional to its share price.
💡 Example
Stock A: $500 share price
Stock B: $50 share price
Stock A has 10x the influence on the index, regardless of company size!
Pros: Simple calculation
Cons: Arbitrary weighting, stock splits change weight
= Equal Weighted
Used by: S&P 500 Equal Weight Index (RSP ETF)
How it works: Each stock has identical weight (for S&P 500 EW, each stock = 0.2%)
Pros: Small caps get equal say, less concentration risk
Cons: Doesn't reflect economic reality, more turnover/rebalancing
Global Indices
Major indices around the world for international diversification:
🇪🇺 Europe
| 🇬🇧 FTSE 100 | UK's 100 largest companies | Financial, energy, pharma heavy |
| 🇩🇪 DAX 40 | Germany's 40 largest | Industrial powerhouse |
| 🇫🇷 CAC 40 | France's 40 largest | Luxury goods, energy |
| 🇪🇺 Euro Stoxx 50 | Eurozone's 50 largest | Broad European exposure |
🌏 Asia-Pacific
| 🇯🇵 Nikkei 225 | Japan's 225 largest | Price-weighted, tech/auto heavy |
| 🇭🇰 Hang Seng | Hong Kong's 50 largest | Gateway to Chinese companies |
| 🇨🇳 Shanghai Composite | All Shanghai-listed A-shares | Mainland China, restricted access |
| 🇮🇳 SENSEX | India's 30 largest (BSE) | Growing emerging market |
| 🇰🇷 KOSPI | South Korea's main index | Samsung, tech heavy |
| 🇦🇺 ASX 200 | Australia's 200 largest | Mining, banks, healthcare |
🌍 Broad International
| MSCI World | 23 developed markets | Global developed exposure |
| MSCI EAFE | Europe, Australasia, Far East | Developed ex-US |
| MSCI Emerging Markets | 24 emerging markets | China, India, Brazil, etc. |
| MSCI ACWI | All Country World Index | Developed + Emerging |
Using Indices as an Investor/Trader
📏 1. Benchmark Your Performance
Compare your portfolio returns to relevant indices. If your portfolio returned 8% but the S&P 500 returned 15%, you underperformed the market—you would have been better off just buying an index fund.
Choose appropriate benchmarks:
- Large-cap US portfolio → S&P 500
- Tech-heavy portfolio → NASDAQ-100
- Small-cap portfolio → Russell 2000
- International portfolio → MSCI EAFE or ACWI
📈 2. Gauge Market Sentiment
Indices show overall market direction and sentiment:
- Indices up, VIX down: Risk-on, bullish sentiment
- Indices down, VIX up: Risk-off, fear/uncertainty
- Small-caps outperforming: Risk appetite increasing
- Defensive sectors leading: Investors getting cautious
📊 3. Trade the Index Directly
You can trade indices through various instruments:
| Instrument | Examples | Best For |
|---|---|---|
| ETFs | SPY, QQQ, IWM, DIA | Long-term holding, simplicity |
| Futures | ES (S&P), NQ (Nasdaq), YM (Dow) | Leverage, hedging, active trading |
| Options | SPY/QQQ options, SPX options | Hedging, income, speculation |
| Leveraged ETFs | TQQQ (3x), SPXL (3x), SQQQ (-3x) | Short-term trades only |
🔍 4. Sector and Style Analysis
Compare sector and style indices to identify rotation:
- Russell 2000 vs S&P 500 → Small vs Large cap preference
- Growth vs Value indices → Style rotation
- Sector SPDRs (XLF, XLK, XLE) → Sector money flow
Popular Index ETFs
| ETF | Tracks | Expense Ratio | Assets |
|---|---|---|---|
| SPY | S&P 500 | 0.09% | $500B+ |
| VOO | S&P 500 | 0.03% | $400B+ |
| IVV | S&P 500 | 0.03% | $400B+ |
| QQQ | NASDAQ-100 | 0.20% | $200B+ |
| DIA | Dow Jones | 0.16% | $30B+ |
| IWM | Russell 2000 | 0.19% | $50B+ |
| VTI | Total US Market | 0.03% | $350B+ |
| VXUS | International (ex-US) | 0.07% | $60B+ |
| VEA | Developed Markets | 0.05% | $100B+ |
| VWO | Emerging Markets | 0.08% | $70B+ |
💡 Why Index Funds Often Beat Active Managers
Over 15-year periods, approximately 90% of actively managed funds underperform their benchmark index after fees. Index funds offer:
- Lower fees: 0.03% vs 1%+ for active funds
- Tax efficiency: Less trading = fewer taxable events
- Diversification: Automatic exposure to hundreds of stocks
- Consistency: No manager risk or style drift
Warren Buffett recommends index funds for most investors!
Key Takeaways
- S&P 500 is the primary US market benchmark, covering ~80% of US market cap
- Dow Jones is price-weighted with only 30 stocks—less representative but widely quoted
- NASDAQ Composite and NASDAQ-100 are tech-heavy and more volatile
- Russell 2000 tracks small-caps; often leads market turns
- VIX measures expected volatility—the market's "fear gauge"
- Market-cap weighting is most common; price weighting (Dow) has arbitrary distortions
- Global indices (MSCI, FTSE, etc.) provide international diversification benchmarks
- Index ETFs offer cheap, diversified exposure—most active managers underperform them