The third index that we will look at is the NASDAQ Composite Index. Unlike the other indices that we have reviewed (S&P 500 and Dow Jones Industrial Average), the NASDAQ Composite consists only of stocks that trade on the NASDAQ. A brief review of the NASDAQ exchange is thus a good place to start.
Brief History of the NASDAQ
In 1938, Congress passed The Maloney Act, which amended the 1934 Securities Exchange Act. The purpose of the amendment was to better regulate the “over the counter” (OTC) market, where securities traded directly among dealers, outside the intermediation of a stock exchange. The Maloney Act required the creation of “self regulatory organizations” (SROs) to regulate OTC markets. These SROs would operate under the jurisdiction of the Securities and Exchange Commission (SEC).
In 1938, OTC market participants banded together to form the National Association of Securities Dealers (NASD) in fulfillment of the requirements of The Maloney Act. The organization registered with the SEC in 1939 and would go on to become the main self-regulatory body for the securities industry.
In 1971, the NASD formed the National Association of Securities Dealers Automated Quotations (NASDAQ). This was originally not a trading platform. Rather, it was an electronic system (by 1971 standards) where OTC dealers could post their quotes. But soon a dealer network formed around these quotations.
Although technically still an OTC market, the NASDAQ’s vast dealer network allowed companies to raise significant sums in public offerings. Because the listing requirements were lower than those on the New York Stock Exchange, the NASDAQ attracted young technology companies such as Apple, which went public in 1980, and Microsoft, which went public in 1986. The NASDAQ has continued to be the favored market for technology companies.
Unlike the New York Stock Exchange and (at the time) other regional stock exchanges, the NASDAQ never had a physical location. Trades initially occurred via telephone but eventually moved to computer servers. In 1998, the NASDAQ became the first stock market to allow online trading.
In 2006, the NASDAQ became a National Securities Exchange.
The Composition of the NASDAQ Composite
The NASDAQ Composite was created alongside the NASDAQ itself. Thus, the index dates back to 1971, and opened with a base value of 100.
Like the S&P 500, the NASDAQ Composite is weighted by market capitalization. And like other indices, there are many funds that track the performance of the index, allowing investors to capture the index performance at a low cost.
The S&P 500 is biased towards information technology because of the size of larger companies, such as Apple, Nvidia, and Alphabet. But the stocks within the S&P 500 are spread across a variety of industries. In contrast, the NASDAQ Composite is even more heavily concentrated in information technology, both by virtue of its market capitalization-weighted composition and also because most of the stocks in the index are in information technology.
I explore how this concentration plays out in the S&P 500 — including sector weights and the influence of its largest companies — in my post Understanding Stock Indices: How the S&P 500 Shapes the Market.
Why the NASDAQ Composite Matters
The NASDAQ Composite is mostly viewed by investors and traders as a gauge for the health of the technology sector rather than a gauge of the overall stock market.
At a glance, the NASDAQ Composite is:
- Exchange-specific — includes only NASDAQ-listed stocks
- Market-cap weighted — like the S&P 500, larger companies dominate
- Tech-heavy — more concentrated in IT than other major indices
- A sector barometer — commonly used to track the performance of technology companies
Summary
The NASDAQ Composite Index differs from the S&P 500 and the Dow Jones Industrial Average in that it includes only companies traded on the NASDAQ exchange. It emerged out of regulatory changes that reshaped the OTC market and quickly became the central marketplace for technology firms, a concentration that is still reflected in the index today. As a result, investors tend to view the NASDAQ Composite less as a broad market benchmark and more as a real-time indicator of the tech sector’s health.
For a visual walkthrough of how the NASDAQ works, we cover the fundamentals on our YouTube channel, including a short explainer titled What Is the NASDAQ?
Key Takeaways
- The NASDAQ originated from reforms to better regulate OTC markets.
- It evolved into the premier exchange for technology companies due to lower listing requirements.
- The NASDAQ Composite is market-cap weighted and heavily tech-focused.
- Investors use the index primarily to assess the state of the technology sector.
- Its structure and history distinguish it from broader indices like the S&P 500.
