When most people talk about the market, they are likely referring to the Dow Jones industrial average, the index most commonly cited when describing stock market movements.
The oldest major index, the Dow dates back to the mid-1880s, when it tracked 12 stocks. It began tracking 30 in the 1920s, the same number it tracks today.
That might have been adequate almost 100 years ago, but in 2015 there were more than 4,000 publicly traded companies in the U.S. and more than 40,000 worldwide. So following the Dow in isolation might give you a view of stock performance that is inconsistent with the broader reality.
Take Oct. 26, when the Dow closed with a gain of 30.06 points. What does this tell you about stock performance that day? Probably a bit more up than down, right?
You would be wrong. Nearly twice as many stocks fell as rose that day, according to data from Yahoo Finance. Other big indexes were down.
The Dow is the only major index that is price-weighted. The higher the underlying stock's price, the more it moves the Dow.
For example, Goldman Sachs, trading at around $178 per share, counts for around 6.7 percent of the movement of the Dow. However, its market cap — the value placed on it by public-market investors — is $73 billion, or only 1.3 percent of the collective market cap of the 30 companies.
A company's market cap is a much better way to weight the components of an index. The companies with the largest market cap typically have a greater influence on the movement of stocks across multiple indexes.
