What Is the Dow & NASDAQ?
The Dow Jones Industrial Average (Dow) and NASDAQ 100 (NASDAQ) are two of the most commonly tracked stock indices in the United States. The Dow measures changes in stock prices for some of the largest companies in the U.S. The NASDAQ measures changes in the 100 largest stocks listed on the NASDAQ stock exchange, which tends to include more technology stocks than the Dow. The computational methods used by the NASDAQ and Dow differ from one another, but often the percentage changes on each exchange is fairly similar to the other.
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Computation of the Dow
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The Dow is computed based on changes to the stocks of 30 companies that make up the Dow Jones Industrials. These companies tend to be very large and tend to be associated with "old industry" businesses like finance and manufacturing as opposed to new technology. The Dow values stocks using a price-weighted method such that stocks with high prices have more effect on the index than stocks with low prices.
Computation of the NASDAQ
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The NASDAQ uses a "modified capitalization-weighted" methodology. This means that larger companies are weighted more heavily than smaller companies and the price per share of the stock does not have any bearing. The NASDAQ does not include any financial stocks, but it does include a small number of international stocks. Generally speaking, it is more focused on technology stocks than most other stock indices.
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Comparison of Dow and NASDAQ
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The NASDAQ more closely measures a portfolio of its underlying stocks than the Dow does. The Dow gives more weight to stocks based on the price of the stock per share. This causes it to understate the effect of large swings in a low-priced stock. For example, a $10 stock could go up 10 percent (i.e., $1) and it would have the same effect on the index as a 1 percent increase of a $100 per share stock.
The NASDAQ more closely tracks the overall effect of changes in the underlying stocks than the Dow does. For example, changes in a large company like Apple get more weighting than a similar change in a smaller company. The theory is that the change in a big company has a broader impact than the change in the smaller company.
Benefits of Stock Indices
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The Dow and NASDAQ are very convenient tools to assess general trends in stock markets. Because the component stocks used by the Dow and NASDAQ differ from one another, in combination they provide a broad view of changes in the U.S. stock markets. Tracking general trends in the stock market helps determine the overall health of the economy because stock prices are often affected by company profitability.
Alternatives to the Dow and NASDAQ
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The Dow and NASDAQ are very commonly referenced stock indices, but they are not the only indices that are available. For example, the Standard & Poor's 500 (S&P 500) index tracks changes in the 500 largest companies in the U.S. The Wilshire 2000 tracks the 2,000 largest companies. By including more companies than the S&P 500, the Wilshire 2000 includes many small cap stocks that are not measured by other indices. Likewise, there are indices that track stocks on various foreign stock exchanges, such as Tokyo and London.
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References
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