The Dow Jones Industrial Average and the NASDAQ Composite are stock indices used to measure how stocks have traded in the United States. Although both are used as benchmarks for the overall stock market, they work in very different ways.
The Dow Jones Industrial Average is an index made up of 30 of the largest publicly-traded companies. It was started in the late 1890s to track the stock prices in the industrial sector. Today, however, the index isn’t limited strictly to industrial companies. There are large companies from every sector of the economy included in the average.
The Dow Jones employs a price-weighted average. It is calculated by combining the prices of each component stock in the index and dividing it by a divisor. The divisor is not simply the number of companies in the index. It’s actually a constant based on the number of companies in the Dow Jones that takes into account stock splits and dividends. The divisor is adjusted each time this occurs.
The NASDAQ Composite, on the other hand, is a much more modern institution and is typically considered more accurate indicator of the overall stock market. The NASDAQ was started in 1971 in an attempt to consolidate the Over-The-Counter (OTC) market. When it first began, it indexed 2500 companies and had a base value of 100 points. It now tracks all the companies, over 3500, on the NASDAQ Stock Exchange.
Unlike the Dow Jones, the NASDAQ uses a market capitalization method to calculate its average. The market capitalization is calculated by multiplying the number of outstanding shares of a stock by its stock price. The market capitalizations of all the companies are combined and divided by the number of companies in the index. The gives larger companies a bigger influence on the overall direction of the index and also takes into account any stock splits that may occur.
Historically, the NASDAQ Composite has primarily been composed of companies in the technology industries, but that’s changed in recent years. The NASDAQ is now the second largest stock exchange in the United States, and the NASDAQ Composite indexes all of the companies traded on the exchange.
The Dow Jones Industrial Average has been around for so long that most people closely associate it with overall stock market health, but since it only includes 30 of the largest companies, it accurately represents only a small portion of the market. The NASDAQ Composite, made up of more than 3500 companies both large and small, is a far better indicator of the health of the stock market.