Monday, February 15, 2010

Market Up, Market Down

When I read in the news or hear people say that the market was up today or that it has been down lately, what exactly are they referring to?

When you hear "the market is up" or "the market is down" in all likelihood, what people are referring to is how the main stock indices have performed in the referenced period.

A stock index is a numeric value that consists of the weighted average of the prices of its components. It is a simple and practical way to see how stocks (also called equities) have performed. If you read that the market was "up" that does not necessarily mean that all stocks were up but merely that in general it is likely that a stock has performed somewhat closely paralleling what the index that contains it has done.

When there are news or events that change the value (or more accurately, the perception of value) of a specific stock it is quite often the case that a specific stock or sector will also move independently from what the general indices are doing (i.e. a certain stock can be up 15% while the market is down 1% and viceversa)

The main stock indices that the media normally reports on are:

Dow Jones (the Dow) : 30 Large-cap industrial Companies
S&P 500: 500 Large-cap to mid-cap companies in the USA
NYSE Composite: All the companies (1834) that trade in the NYSE market
Nasdaq Composite: All the companies (2764) that trade in the NASDAQ market
Nasdaq 100: 100 Large-cap non-financial companies that trade in the NASDAQ market
Russell 2000: 2000 Small-cap companies trading in the USA

For example, the S&P 500 index had a value of 903.25 on December 31st, 2008 and it finished the year with a value of 1115.10 on December 31st, 2009. This means that the S&P increased in value by around 23.45%.

Just to illustrate the variation in performance within an index, let's take XL Capital (ticker: XL) which went from a price of $3.70 at the beginning of 2009 to $18.33 by the end of the same year (395% return) and compare it to Marshall & Ilsley, owner of M&I Bank (ticker: MI) which went from $13.55 to $5.45 in the year 2009 (for a -59.7% return). Both companies belong to the S&P 500 index and they even operate broadly in the same sector (Financials) but their returns were quite different.

There are several global indices (rest of the world) that the media reports on quite often but we'll cover them in another article.

As a trader, I follow only 2 indices and they provide me with a very clear picture of what's happening in the stock market:

S&P 500: US Market in general
Nasdaq-100: Technology stocks

Sometimes just to get a sense of what the risk appetite is I would look at the Russell 2000. Usually, if the Russell 2000 is outperforming the S&P 500 it is an indication that investors are embracing risk (since small-cap companies usually represent higher risk) as opposed to shying away from it if it is underperforming.