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Every move of stock indexes is closely watched and, on occasion, celebrated, like when the Dow Jones closed above 27,000 points in July. But what do those closing numbers actually mean?
Each index is different
Stock indexes measure different things. For example, the Dow Jones tracks 30 large companies, while the S&P measures the 500 biggest American stocks and weights them based on their size. Consequently, the numbers mean different things across different indexes, said Andrea Eisfeldt, professor of finance at UCLA Anderson.
There’s a lot that goes into calculating a stock index’s closing number. We’ll look at the S&P 500 as an example.
Understanding market caps
A company’s market cap, short for market capitalization, shows how much it’s worth on the stock market on any given day. To calculate the number the S&P closes at, first you have to know each company’s market cap.
“If you have a stock like Apple, you just take its price,” said Eisfeldt. “And then you multiply it by the number of shares that are traded on U.S. stock exchanges.”
Once multiplied, that number represents Apple’s market cap.
How does this get back to the S&P’s closing number?
Each company has its own market cap that changes every day with share prices. The sum of all of these companies’ market caps is the S&P 500’s market cap. Before the closing number is reported, the index’s market cap is divided by an index divisor, to ensure one company’s action doesn’t rattle the whole S&P.
What to pay attention to
“I think people should know what it means for the S&P to be at a certain level, but I think it’s more important to look at the percentage changes,” said Eisfeldt. Unlike fluctuating numbers, percentage changes show the net change to an index over time.
To find out more about what drives the stock market, click here.
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