Stock Market Indices Explained: S&P 500, Dow and Nasdaq

How does the Dow finish a session higher while the S&P 500 finishes lower, when hundreds of the same companies are trading in both? Because they are not measuring the same thing. An index is a formula with a membership list, and the three quoted in every headline use three different formulas. Two are defensible. One is a nineteenth century arithmetic shortcut that nobody would design today.

Three decisions define any index: which companies are in, how much each one counts, and what happens when the list changes. Nobody can buy the formula. Funds track it by holding the constituents in the same proportions, which is where the fee and the tracking difference enter, and that relationship is the subject of index funds explained.

Cap weighting, the S&P 500 method

The S&P 500 weights each company by its float-adjusted market capitalization. Market capitalization is share price times shares outstanding. Float adjustment strips out shares that are not available to public investors. Think large insider or government stakes. Three companies are enough to see the mechanics.

Company	Price	Float shares	Market value
A	100	10,000,000	1,000,000,000
B	40	5,000,000	200,000,000
C	25	4,000,000	100,000,000

The index total is $1,000,000,000 + $200,000,000 + $100,000,000 = $1,300,000,000. Company A’s weight is $1,000,000,000 / $1,300,000,000 = 76.9%, B is 15.4%, C is 7.7%.

Let C rise 10 percent, from 25 to 27.50. Its value becomes 4,000,000 x $27.50 = $110,000,000 and the total becomes $1,310,000,000. The index gained $10,000,000 / $1,300,000,000 = 0.77% out of a 10 percent move in a third of its members.

Now let A rise 10 percent instead. Its value goes to $1,100,000,000, the total to $1,400,000,000, and the index gains $100,000,000 / $1,300,000,000 = 7.7%. Same percentage move, ten times the effect.

Price weighting, and why the Dow is a museum piece

The Dow Jones Industrial Average holds 30 companies and weights them by share price. Size plays no part at all.

Build a price-weighted index from the same three companies. Prices sum to $100 + $40 + $25 = $165. Divide by a divisor, which starts as the number of stocks: $165 / 3 = 55.00.

C rises 10 percent, adding $2.50 to its price. The sum is $167.50 and the index is $167.50 / 3 = 55.83, a gain of $2.50 / $165 = 1.5%. A rises 10 percent instead, adding $10, giving $175 / 3 = 58.33 and a gain of $10 / $165 = 6.1%. The only input that mattered was the dollar change in price, which is how a high-priced stock ends up dominating the Dow whatever the company is worth.

The divisor keeps the series continuous. If A split two for one, its price would halve to 50. The sum would drop to $115. Nothing economic has happened. So the divisor resets: $115 / x = 55.00 gives x = 2.0909. That adjustment has been repeated for splits and membership changes since 1896, and the divisor now sits well below 1, meaning a one dollar move in any Dow component moves the index by more than one point.

The two Nasdaqs

Two different things share the name. Financial media rarely bothers to say which one it means. The Nasdaq Composite includes essentially every common stock listed on the Nasdaq exchange, several thousand of them, cap weighted, while the Nasdaq 100 covers the 100 largest non-financial companies on that exchange, also cap weighted, under a modified scheme that caps the largest members to limit concentration.

Nearly every fund marketed as a Nasdaq tracker follows the 100. Because Nasdaq listings skew heavily toward technology, both indices behave as concentrated sector bets while neither is formally a sector index.

Index	Constituents	Weighting	What it tells you
S&P 500	500 large U.S. companies	Float-adjusted market cap	Broad U.S. large company performance
Dow Jones Industrial Average	30 companies	Share price	A long historical series, chosen by committee
Nasdaq Composite	Nearly all Nasdaq listings	Market cap	Nasdaq-listed market, technology heavy
Nasdaq 100	100 largest non-financial Nasdaq firms	Modified market cap	Large technology and growth performance
Russell 2000	2,000 smaller U.S. companies	Market cap	Small company performance

Who picks the members, and what that does to prices

A committee at S&P Dow Jones Indices selects the S&P 500 against published criteria: U.S. domicile, minimum market capitalization, sufficient public float, adequate trading liquidity and a recent record of positive earnings. Eligibility is not entitlement. The committee keeps discretion over both selection and timing.

The Russell indices are rebuilt annually by a mechanical ranking of market capitalization, which turns the reconstitution date into one of the highest volume sessions of the year as tracking funds adjust.

Additions and deletions move prices, because index funds have to buy or sell to keep tracking, and every one of those trades is a forced order with a known date, which makes it one of the very few things in this market you can put in a diary in advance.

Equal weighting, and the concentration question

A third rule sits alongside the other two. An equal weighted index gives every constituent the same share, so in a 500 stock index each company carries 1 / 500 = 0.2% whatever its size.

Back to the three companies. Cap weighted, A carried 76.9 percent. Equal weighted, each carries 1 / 3 = 33.3%, so C rising 10 percent lifts the index by 0.333 x 10% = 3.33% against the 0.77 percent it produced under cap weighting.

The trade is maintenance. Weights drift as prices move, so an equal weighted index rebalances regularly, usually quarterly, selling what rose and buying what fell, and that turnover is why funds tracking it charge more than their cap weighted equivalents.

People reach for equal weighting when concentration gets uncomfortable. When the largest handful of companies grow to a very large combined share of a cap weighted index, the index becomes a bet on those names whether or not that was your intention. Comparing a cap weighted return with its equal weighted version over the same period is a fast measure of how much of a move came from the giants.

What the level does not tell you

An index level says nothing about whether stocks are expensive. It rises with earnings growth, with inflation and with new share issuance over decades, so holding today’s level against a level from 1999 without adjusting for any of that is a meaningless comparison that gets made constantly.

It hides breadth. The S&P 500 can close up 0.4 percent on a day when more constituents fell than rose, because a few large companies carried it, and the market breadth tool shows the advancing and declining counts behind a session, while the sector heatmap shows which parts actually moved.

And most published index levels are price returns, which exclude dividends. Total return versions include reinvested dividends and are materially higher over long periods. Check which version a chart uses before you set it against a fund’s performance, because the comparison is otherwise rigged in one direction.

Where to go next

Index funds explained covers how a fund turns one of these formulas into something you can own, and what is an ETF explains the wrapper most people use to do it. For the machinery underneath, read how the stock market works and what is Wall Street. The stock market basics quiz includes the weighting arithmetic above.