What does it mean when the news says "the market" went up 1%?
"The market" in the evening news is a list of a few dozen or a few hundred companies, and the list is weighted in very different ways.
▶ Start the storyWhen the news says the market rose 1%, it means an index rose 1%. A stock market index measures the performance of a stock market, or a subset of it, so investors can compare today's price levels with past ones. It is a way of summarising a market, or part of one, in one number.
One of the first belongs to Charles Dow, a journalist, and his business partner Edward Jones, a statistician, who founded Dow Jones & Company. In 1884 they created the first stock average, with 11 stocks, mostly railroads. On 26 May 1896 the Dow Jones Industrial Average debuted with 12 industrial stocks, at a starting value of 40.94. Today it tracks 30 large US companies. The S&P 500, which tracks 500 large US companies, took its current shape in 1957.
The surprise is that "the market" depends on how you add the companies up. The Dow is price-weighted: the stocks with the highest price per share count the most. The S&P 500 is weighted by market capitalization, so bigger companies count more. Two indexes can look at the same stocks and still tell slightly different stories.
Price-weighted (the Dow)
- The highest share price counts most
- A split lowers a company's weight
- 30 large US companies
Cap-weighted (the S&P 500)
- Price times shares outstanding
- The bigger company counts more
- 500 large US companies
The Dow has quirks that come from its method. It is computed as the sum of the prices divided by a divisor that is adjusted for stock splits, so that a split does not change the index. And because it has only 30 components, it is not considered representative of the US economy.
An index can also be bought: an index fund is a mutual fund or exchange-traded fund that tracks one.
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Recap
"The market" is a list plus a weighting rule: change either one and the number changes.
💡 A trick to remember it · An index is a recipe: pick the ingredients, choose how much of each, and the dish tastes different.
Surprising fact · The Dow is price-weighted, so a stock split lowers a company's weight though nothing about the company changed.
Sources (3)
No source, no claim. Every fact in this lesson (23 claims) cites at least one of these.