What is the Nasdaq?

Picture your one tech-obsessed buddy (everyone’s got one)...

She can’t stop talking about APIs and she learned to code before she could text. That’s like Nasdaq. Born out of technology innovation, it is known for attracting tech companies to list their shares for IPOs. And its Nasdaq Composite index is generally used by investors as a reflection of the whole tech industry’s stock performance.

You’re going to hear the term “Nasdaq” used in two ways.

1. “How’s the Nasdaq doing?” That refers to the Nasdaq’s stock index, the Nasdaq Composite, which reflects the tech industry’s broader stock movements (more on that below).
2. The Nasdaq Exchange is the world’s first electronic trading floor on which companies (often tech companies) list their shares — Many of those companies (over 3,500 of them) are then tracked on the Nasdaq Composite index to give a sense of how the technology sector is doing (more on that here).

The world’s second largest stock exchange by market capitalization and first electronic one was launched on February 7, 1971 by the National Association of Securities Dealers. First, it allowed automated quotations and then began providing trading of stocks. The idea was to incorporate new technology — which at the time was computers — to make trading as electronic and efficient as possible.

Nasdaq soon grew a rivalry with the New York Stock Exchange (“NYSE”) as it increasingly focused on technology as a differentiator. Nasdaq’s stock market became the first to allow trading online. And unlike the NYSE, Nasdaq does not have a trading floor with people taking orders from each other — It’s purely electronic. As tech companies looked to list shares publicly in an IPO, Nasdaq’s commitment to technology attracted a variety of tech companies such as Microsoft or Oracle.

Nasdaq continued to expand its stock market through partnerships and acquisitions. For example, it acquired the Philadelphia Stock Exchange and then formed its first “intercontinental linkage” with the London Stock Exchange in 1992. In 2006, Nasdaq separated from its original founding partner, NASD, so that it could operate nationally as a stock exchange. A year later, it added a Scandinavian-based Exchange, OMX.

While the New York Stock Exchange (NYSE) continues to have a larger market cap than that of the Nasdaq as of August 2022, the Nasdaq has closed the gap in recent years. The NASDAQ grew at 6% per year between 2015 and 2019, twice as fast as the NYSE over the same period. In 2021, the Nasdaq hosted over $190B worth of IPOs, and the NYSE, over $109B worth of IPOs.

Looking at a few stocks doesn’t necessarily tell you how the market as a whole is doing. Stock indexes help with that — They’re formulas that create one number to measure the broader market or a specific industry, to give you a sense of how it’s doing in a single snapshot. Stock indexes are calculated using the stock prices of its member companies.

When an investor wonders what’s up with the tech sector, they typically turn to the Nasdaq Composite. Though many more companies have listed their shares on the Nasdaq Exchange, a select 3,500+ are included in this Nasdaq stock index. And the Nasdaq Composite has a few key features:

• It’s tech heavy: Since a large proportion of companies listed on the Nasdaq exchange are included in the index, and most companies on the Nasdaq exchange are tech companies, the Nasdaq has a heavy tech influence.
• It’s weighted: The stocks are weighted in the index to account for their different sizes (their size is their value by market capitalization). That’s because tech giant Amazon’s value is much bigger than tech camera pioneer GoPro’s, so the index uses a formula to account for that.
• It’s international: Unlike other indexes (like the S&P 500 or the Dow), Nasdaq Composite companies aren’t only based in the US.
• It’s not just stocks: The index includes a variety of tech-related securities, including real estate investment trusts (REITS are tradeable real estate investments), Exchange Traded Funds, and American Depository Receipts (ADRs are foreign stocks trading in the US), to name just some of them.

Throughout the day, the Nasdaq Composite is calculated based on prices reviewed once every second. At the end of the trading day, the final Nasdaq Composite is determined and reported at 4:16pm EST (markets close trading at 4pm EST).

Welcome to “The Methodology” — That’s Nasdaq’s (proudly) mathematical process for figuring out a final Nasdaq Composite index number. Remember, it’s got to take 3,500+ stock values and turn them into a single stock index number. And the process involves 3 key elements: A weighted number, the “Last Price” (the most recent price of the security on the list), and the “index divisor.”

Here’s how it goes down. First, Nasdaq uses a method of weighting a stock by its market capitalization to make sure its influence on the final number corresponds to the company’s size. Then all the share weights of each security involved are multiplied by the security’s most recent price. The sum of those figures is then divided by an “index divisor” determined by Nasdaq. And voila, you’ve got the Nasdaq Composite index.

The index isn’t purely technology; it’s made up of different industries as well — Here’s how they fall within the Nasdaq Composite by industry as of September 30, 2022, from the most represented to the least represented sector:

• Information Technology (43.16%)
• Consumer Discretionary (16.89%)
• Communication Services (13.71%)
• Health Care (9.15%)
• Financials (5.08%)
• Consumer Staples (4.58%)
• Industrials (4.39%)
• Utilities (1.02%)
• Real Estate (0.95%)
• Energy (0.75%)
• Materials (0.32%)

The big three. Turn on a financial TV show and you’ll notice tickers streaming across the stream, highlighting the movements of the main three stock market indexes. The Nasdaq Composite is our tech-focused index, but the S&P 500 and the Dow Jones Industrial Average (aka “the Dow”) round out the other two — And there are a few key differences.

Different number of companies: Each index includes a different number of public companies.

• The Dow is a 30-member club of big, well-known public companies selected to represent a significant portion of the diverse US economy.
• The S&P 500 is some of the largest 500 public companies in the US.
• The Nasdaq Composite is over 3500 companies, with a focus on tech.

Different focus: When investors want to know “how’s the market doing,” they don’t typically turn to the tech-limited Nasdaq — They look at the S&P 500 and the Dow.

• The Dow represents 30 well-known, “blue chip” public companies for the purpose of reflecting a diverse, though limited, snapshot of the market.
• The S&P 500 is often considered a better snapshot of the US stock market than the Dow because it includes more diversity and a bigger set of companies.
• The Nasdaq Composite shows how the broader technology market is doing by including a large and diverse group of companies from the technology sector — But it’s not as helpful a measurement of the broader market since it’s not well represented by other industries like food or fashion.

Different calculations: To take a bunch of companies of different valuations and different stock prices and turn them into a single index number requires a formula. Each formula is different. That’s why, as of October 2022, the Dow stood at around 30,185 points, the S&P 500 at 3,677 points, and the Nasdaq Composite at 10,675 points.

-The Dow has a lot fewer stocks and is weighted by stock price. So the company with the highest dollar stock price carries the most weight in the index and will therefore influence the Dow’s number the most.

• The S&P 500 and Nasdaq are both weighted by market capitalization, which for some investors might make more sense since they see it as a more accurate reflection of what the index should measure. That’s because a company’s value as measured by market capitalization accounts for both the stock price and the number of shares outstanding in the market.

Different movements: Since all three indexes have a different number of companies, areas of focus, and even calculations, you’ll notice they experience different movements. Let’s focus on one period of time, the Dotcom bubble in the late 1990s, to see that in action:

• The Nasdaq rose from under 1,000 points in 1995 to over 5,000 in 2000 driven by the Dotcom bubble. But investors bought up tech company stocks in an unsustainable way, the bubble “burst” from 2001 through 2002, and the Nasdaq almost fell back to 1,000.
• The Dow and the S&P 500 also experienced a rise of the Dotcom bubble and then the fall as it burst. But their increase and decrease were not nearly as large as the Nasdaq’s because the Dotcom bubble most heavily affected the stocks of tech companies.

Disclosure: It is not possible to invest directly in a market index. Indices are not subject to any fees or expenses.