-- Q: How can investors better understand the differences between the Dow Jones industrial average, Standard & Poor's 500 and Nasdaq?
A: Investors often group the different market measures together and assume they're interchangeable. After all, the Dow Jones industrial average, Standard & Poor's 500 and Nasdaq composite all measure the value of stocks, right?
Wrong. While the basic mission of these three market measures is similar, the way they go about the task is very different. And for that reason, all three measures can give you a completely different take on how stocks are doing.
And that's been the case already this year. The Dow has been leading the Standard & Poor's 500 index this year, despite the fact both measure the value of U.S. stocks.
The more you learn about the different market indexes, the more you can see why they often don't move in lock step. The key parts of each index you must understand include:
•The calculation methodology. The value of a market measure is the result of a mathematical calculation. And the differences can be big between indexes. The Dow Jones industrial average gives greater weight to stocks with the highest per-share price. That means that IBM, trading for nearly $200 a share, has a much greater weighting than Bank of America, which trades for less than $10 a share.
The Standard & Poor's 500 index is weighted by market float of shares. That means the companies with the greatest value of shares available to be traded are given the largest weighting in the index. Large companies that have big slices of their company held by a founding family, and the shares don't trade in the public's hands, don't count as much in the value of the S&P 500 index.
The Nasdaq composite index, lastly, is weighted based on market value. That means the companies with the greatest total market value hold the most sway in the Nasdaq.
•The selection methodology. Another key aspect that determines the value of indexes is the type of companies that are included. The Dow tracks the value of 30 large companies which tend to be blue-chip firms that are household names. The S&P 500 tends to be broader, hoping to have a bigger representation of companies from various sectors and industry groups. And the Nasdaq composite includes only stocks that are traded on the Nasdaq market.
Just these two characteristics can create three very different indexes. The Dow tends to be the blue-chip index and a measure of the biggest companies, but leans heavily toward what the stocks with the highest share prices are doing. The S&P 500 tends to more closely follow the entire market. In fact, the S&P 500's market weighting in financials is a big reason why it's been trailing the Dow. And the Nasdaq tends to be weighted heavily in favor of big technology companies, since those are the kinds of companies that dominate that exchange.
Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies and Fundamental Analysis for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at firstname.lastname@example.org. Follow Matt on Twitter at: twitter.com/mattkrantz