Stock market indicators have come to perform a variety of functions, from serving as benchmarks for evaluating the performance of professional money managers to answering the question, “How did the mar- ket do today?” Thus, stock market indicators (indexes or averages) have become a part of everyday life. Even though many of the stock market indicators are used interchangeably, it is important to realize that each indicator applies to, and measures, a different facet of the stock market.
The most commonly quoted stock market indicator is the Dow Jones Industrial Average (DJIA). Other popular stock market indicators cited in the financial press are the Standard & Poor’s 500 Composite (S&P 500), the New York Stock Exchange Composite Index (NYSE Composite), the NASDAQ Composite Index, and the Value Line Composite Average (VLCA). There are a myriad of other stock market indicators such as the Wilshire stock indexes and the Russell stock indexes, which are followed primarily by institutional money managers.
In general, market indexes rise and fall in fairly similar patterns. Although the correlations among indexes are high, the indexes do not move in exactly the same way at all times. The differences in movement reflect the different manner in which the indexes are constructed. Three factors enter into that construction: the universe of stocks represented by the sample underlying the index, the relative weights assigned to the stocks included in the index, and the method of averaging across all the stocks.
Some indexes represent only stocks listed on an exchange. Examples are the DJIA and the NYSE Composite, which represent only stocks listed on the NYSE or Big Board. By contrast, the NASDAQ includes only stocks traded over the counter. A favorite of professionals is the S&P 500 because it is a broader index containing both NYSE-listed and OTC-traded shares. Each index relies on a sample of stocks from its universe, and that sample may be small or quite large. The DJIA uses only 30 of the NYSE-traded shares, while the NYSE Composite includes every one of the listed shares. The NASDAQ also includes all shares in its universe, while the S&P 500 has a sample that contains only 500 of the more than 8,000 shares in the universe it represents.
The stocks included in a stock market index must be combined in certain proportions, and each stock must be given a weight. The three main approaches to weighting are: (1) weighting by the market capitalization, which is the value of the number of shares times price per share; (2) weighting by the price of the stock; and (3) equal weighting for each stock, regardless of its price or its firm’s market value. With the exception of the Dow Jones averages (such as the DJIA) and the VLCA, nearly all of the most widely used indexes are market-value weighted. The DJIA is a price-weighted average, and the VLCA is an equally weighted index.
Stock market indicators can be classified into three groups: (1) those produced by stock exchanges based on all stocks traded on the exchanges; (2) those produced by organizations that subjectively select the stocks to be included in indexes; and (3) those where stock selection is based on an objective measure, such as the market capitalization of the company. The first group includes the New York Stock Exchange Composite Index, which reflects the market value of all stocks traded on the NYSE. While it is not an exchange, the NASDAQ Composite Index falls into this category because the index represents all stocks traded on the NASDAQ system.
Posts Tagged ‘stocks’
Stock Market Indicators, part 1
November 16th, 2010Market Capitalization
November 16th, 2010Market capitalization is defined as the total dollar value of a stock’s out- standing shares and is computed by multiplying the number of outstanding shares by the current market price. Thus, market capitalization is a measure of corporate size. With approximately 8,500 stocks available to trade on U.S. stock exchanges, many traders judge a company by its size, which can be a determinant in price and risk. In fact, there are four unofficial size classifications for U.S. stocks: blue chips, mid-caps, small caps, and micro-caps.
1. Blue-chip stocks. Blue chip is a term derived from poker, where blue chips in a card game hold the most value. Hence, blue-chip stocks are those stocks that have the most market capitalization in the market- place (more than $5 billion). Typically they enjoy solid value and good security, with a record of continuous dividend payments and other desirable investment attributes.
2. Mid-cap stocks. Mid-caps usually have a bigger growth potential than blue-chip stocks but they are not as heavily capitalized ($500 million to $5 billion).
3. Small-cap stocks. Small caps can be potentially difficult to trade be- cause they do not have the benefit of high liquidity (valued at $150 million to $500 million). However, these stocks, although quite risky, are usually relatively inexpensive and big gains are possible.
4. Micro-cap stocks. Micro-caps, also known as penny stocks, are stocks priced at less than $2 per share with a market capitalization of less than $150 million.
Some traders like to trade riskier stocks because they have the potential for big price moves; others prefer the longer-term stability of blue-chip stocks. In general, deciding which stocks to trade depends on your time availability, stress threshold, and account size.