Expert: Paul Henneman - 12/14/2005

Question
Hi Paul

Could you please help me on this question :

Is it recommended to use a market index as an indicator of the whole stock market? Will there be any major shortcomings when using it?

Regards

Answer
Chris,
  Thank you for your question! Yes, I would definitely use market indexes as indicators of the whole stock market. However, as you say there are some shortcomings to be aware of. But if understood properly, indexes can really help you gauge the market.
  The problem is that each index has its focus. So there is no real index that offers an indicator of the entire market. As a few examples, the S&P 500 index is composed of primarly large, well established companies. The NASDAQ 100 represents the largest and most active non-financial companies listed on the nasdaq exchange. The Dow Jones Industrial Average (DJIA) is 30 blue chip stocks, primarily industrial. This is why on any given day you will see different performance for each index (there are many more indexes). The Nasdaq may be up on a given day, and it is possible that the S&P 500 be down on that same day.
   If you are intersted learning more, check out www.standardandpoors.com   Click on the Indices link on the left side navigation links, and see how many indexes Standard and Poors tracks. They have links that discuss methodology on how these are formed as well. You can also see their other indexes for other markets around the world.
   A great resource is the "Barron's Dictionar of Finance and Investment Terms". There is a section for Stock Indices and Averages on page 595, and it goes through the details of about a dozen of the major indexes. This is a great text to have on hand for any investment term questions. It is available on amazon.com and in most major book stores if you are interested.
  I hope this helps! Please do not hesitate to follow up with me if I can be of any further assistance,

Sincerely,
Paul Henneman
ValuEngine, Inc.
www.ValuEngine.com
www.VEInstitutional.com
www.VEReports.com