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What is the Nasdaq?

Jack and Nick Author Pic
Jack Kramer & Nick MartellAugust 26, 2019
Forbes 30 Under 30 in media, appeared on CBS, Cheddar. Registered representatives of Robinhood Financial LLC.
definition

The Nasdaq can refer to two things: 1) Nasdaq Stock Market: an electronic stock exchange for buying and selling stocks, and 2) Nasdaq Composite Index: an index of 3,000 stocks listed on the Nasdaq exchange, which tends to reflect movements of the broader tech industry.

🤔 Understanding the Nasdaq

Think tech. The Nasdaq Stock Market is a stock exchange rooted in technology as the first global electronic marketplace. Built by the National Association of Securities Dealers (NASD) in 1971, Nasdaq was launched to make trading fast and computer-centric (there aren’t any humans on Nasdaq’s trading floor. Just machines). With that tech heritage, the Nasdaq attracted a large number of technology-focused companies to IPO on its exchange. Meanwhile, the Nasdaq Composite Index reflects that — It’s a stock index made up of over 3,000 companies listed on the Nasdaq exchange. Since so many of them are tech companies, investors look to the Nasdaq to gauge how tech stocks are doing.

example

When electric car pioneer Tesla wanted to list its shares publicly, it chose Nasdaq’s stock exchange for its Initial Public Offering (IPO). And within the list of 3,000+ stocks covered on the Nasdaq Composite stock index, tech has a heavy presence: Google, Amazon, Microsoft.

Takeaway

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 used by investors as a reflection of the whole tech industry’s stock performance.

NASDAQ-10

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What’s the history of Nasdaq?
What is the Nasdaq Composite?
How is the Nasdaq Composite calculated?
How are the Nasdaq Composite, the Dow, and the S&P 500 different?

What’s the history of Nasdaq?

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 3,000 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.

Today, as the US economy and stock market have grown more technology-centric, the NYSE has increased its marketing to tech companies. Recent high-profile IPOs of Twitter, Alibaba, and Uber have shown that the Nasdaq no longer dominates the listings of shares of tech companies.

What is the Nasdaq Composite?

Looking at a bunch of stocks doesn’t necessarily tell you how the market 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 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 3,000+ are included in this Nasdaq stock index. And the Nasdaq Composite has a few key features:

  • It’s tech heavy: Since all 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 (ETFs are tradeable funds typically made up of a bunch of stock investments), and American Depository Receipts (ADRs are foreign stocks trading in the US), to name just some of them.

How is the Nasdaq Composite calculated?

It’s non-stop. 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 3,000+ 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 May 2018, from the most represented to the least represented sector:

  • Tech (46.40%)
  • Consumer Services (20.16%)
  • Healthcare (10.86%)
  • Financial (8.59%)
  • Industrials (6.32%)
  • Consumer Goods (5.49%)
  • Oil & Gas (0.71%)
  • Telecom (0.70%)
  • Basis Materials (0.47%)
  • Utilities (0.30%)

How are the Nasdaq Composite, the Dow, and the S&P 500 different?

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 the diverse US economy.
  • The S&P 500 is 500 of the largest public companies in the US.
  • The Nasdaq Composite is over 3,000 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 is an elite club of 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 May 2019, the Dow stood at around 25,000 points, the S&P 500 at 2,800 points, and the Nasdaq Composite at 7,500 points.

-The Dow’s a super exclusive club 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 makes more sense as an effective reflection of what the index measures. That’s because a company’s value 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 since investors bought up tech company stocks in an unsustainable way, the bubble “burst” from 2001 through 2002, the Nasdaq fell almost 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.

The companies listed in this article were chosen based on Nasdaq coverage of the “most actively traded stocks” and “the world’s 10 most valuable brands.” Authors of this article own shares of Tesla and Amazon.

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