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Stock indexes can help
hone your investment
strategies

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THE Dow Jones industrials ... the Nasdaq composite ... the S&P 500 ... the Russell 2000. The list of stock market indexes goes on and on. But how much attention should you pay to all these lists? Actually, if you know the basics of these indexes, you may be able to gain some insights that can help you make better investment decisions.

Some popular indexes

By reading financial publications, you can find a broad listing of stock market indexes. But here, in a nutshell, are a few of the more popular ones:

» Dow Jones industrial average: The Dow, comprising 30 leading companies, is often considered the one index that indicates the general state of the market

» Nasdaq composite index: The Nasdaq tracks the stocks on the National Association of Securities Dealers Automated Quotation System market. Because the Nasdaq includes many companies in the technology sector, this index can rise and fall quickly.

» S&P 500: This index tracks 500 companies in a variety of industries, including transportation, utilities, financial services, and energy. Many money managers and pension plan administrators use the S&P 500 as a benchmark for judging the overall performance of their fund against the stock market.

» Russell 2000: This index measures the performance of 2,000 "small-cap" stocks (stocks of smaller companies just starting to grow). Smaller companies are often newer -- and generally have less capital -- than the larger companies measured by the S&P 500 and Dow Jones. Consequently, the Russell 2000 is more volatile than these indexes.

Use wisely

How can you use these indexes to help yourself become a better investor? For starters, you can employ an index as a "measuring stick" to compare the performance of the stocks you own against other stocks in the same general "universe."

You can also benefit from looking at indexes from a historic perspective. By comparing today's market movements -- as illustrated by various indexes -- against similar movements from the past, you can become aware of important trends and what they have signified. Just go back a few years, to the late 1990s, when the technology-heavy Nasdaq soared before falling hard in 2000. Much of the run-up in that index was caused by unbridled investor enthusiasm in so called "dot-com" companies. But their poor -- or non-existent -- earnings couldn't support their stock prices, which eventually tumbled. If, at some point, you saw a similar thing happening in the Nasdaq, you might want to review your technology holdings.

No substitute

As we've seen, stock market indexes can be useful -- but they can be overused. When an index is down, for instance, investor sentiment can become unjustifiably bearish, which could lead you to avoid investing in high-quality, undervalued companies.

Remember, an index, no matter how large or well constructed, is not a substitute for the entire market -- or for your own good judgment.

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