Function

• A stock index is designed to give investors a cross-section of the overall stock market, or of a particular sector. This is done by tracking a basket of individual stocks and providing a single average or composite price level for the whole. In addition to using this information to generally assess the strength of the particular market, traders speculate directly on indices through options and exchange traded funds (ETFs).
  
  

History

• The oldest of the major American stock indices is the Dow Jones Industrial Average, one of several created by Charles Dow, a 19th-century journalist and entrepreneur. The oldest is actually the Dow Jones Transportation Average, also created by Dow. The DJIA was first published on May 26, 1896, and of the 12 stocks on that original list of American industrial companies, only General Electric exists under the same name today. In 1957, the company created by the merger of Standard Statistics and Poor's Publication, today a division of McGraw-Hill, began printing its S&P 500. The NASDAQ began in 1971 as an automated bulletin board for over-the-counter issues. It evolved into the first entirely electronic exchange, revolutionizing the way stock is traded.
  
  

Features

• In the beginning, the DJIA was a true and simple average: the sum of the prices of the selected stocks divided by the number of stocks. Over time, most of the companies disappeared and others were added; so to prevent the average from being arbitrarily skewed, the price of the new stocks had to be multiplied by a certain factor, or weighted. The stocks in the S&P 500 are market-value weighted from the outset. Stocks that have a larger market capitalization have a larger influence on the index. The Nasdaq is also configured with market-value weighting, calculated quarterly.
  
  

Types

• With the exception of the DJIA, the major indices are subdivided into smaller units. For example, the S&P 100, which trades as OEX, and the Nasdaq 100, trading as NDX, consist of the largest 100 companies on the broader index, excluding financials in the case of NDX. The SPDRs are ETFs consisting of only S&P 500 stocks divided into specific sectors like health care, materials and consumer staples. Other, completely unrelated, indices are popular with some traders--like the Wilshire 5000, an even broader measure of the U.S. economy; the Russell 2000, which tracks only the smallest stocks by market cap; and the NYSE Composite, which includes every stock that trades on the exchange.
  
  

Effects

• Stock exchanges take it upon themselves to halt the trading of individual stocks when they become too volatile, and they're sometimes obliged to stop trading of the entire market. The criteria for the predetermined "circuit-breaker" levels (called "lock limits") vary, but are determined by movement of the major indices. On October 24, 2008, futures trading was halted on all three majors when the circuit breakers were tripped by a 550-point decline in the Dow, a 60-point preopen drop in the S&P 500 and an 85-point nosedive in the Nasdaq.