Which stock index should you follow?

Whether it’s the Dow Jones industrial average, the Nasdaq stock market, Standard & Poor’s 500 index or the Russell 2000, investors use these popular indexes to get a sense of how the overall market is doing.

But these indexes aren’t created equally. The Dow Jones, Nasdaq and Russell 2000 will only give you a glimpse into certain areas of the stock market while the S&P will provide a broader snapshot of market, although it’s mainly for large- to medium-sized companies.

“The S&P 500 is the best barometer because it represents close to 80% of the market cap of all stocks publicly traded,” says Jerry Harris, president of Sterne Agee Asset Management in Birmingham, Ala.

Often, investors will assume a high-flying stock market translates into a booming economy, but that isn’t always the case. The stock market is typically driven by company news, economic data, and rumors and speculation. On the other hand, the economy is driven in part by the number of jobs and workers’ paychecks — not by whether Apple will come out with a new iPhone.

But what the different indexes can do is give investors a sense of certain industries, company sizes and the performance of that market grouping. Here’s a look at how each of the major indexes stack up as indicators of overall stock market performance.

4 stock indexes and their market clout

The Dow Jones industrial average is one of the oldest stock indexes, dating back to the late 1800s. It’s made up of 30 large U.S. companies that are publicly traded. Some of the companies included in the Dow Jones industrial average are American Express Co., Caterpillar Inc., Exxon Mobil Corp., General Electric Co. and Bank of America Corp.

While the stock index is comprised of large U.S. companies, the fact that it only encompasses 30 companies is one reason some analysts say it’s flawed.

“Can 30 companies give an accurate barometer?” says Jared Levy, a stock strategist at Chicago-based Zacks Investment Research. “The lack of diversity is probably the No. 1 reason the Dow is a flawed index.” Read more