Nasdaq, What It Stands For, Its Bubbles and Crashes

How Nasdaq Affects You

NASDAQ building
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Nasdaq is the second-largest stock market in the world. That's thanks to its 2008 merger with OMX ABO, a Stockholm-based operator of exchanges located in the Nordic and Baltic regions. It trades 19.5% of all equities, slightly less than the New York Stock Exchange (NYSE), which trades 23.3%.

Its market capitalization is $11.1 trillion, about half that of the NYSE's market cap of $28.5 trillion. Despite its size, Nasdaq raised $28 billion in initial public offerings (IPO), similar to the $30 billion raised by the NYSE.

Nasdaq is both a stock exchange and an equities index.

Nasdaq is also an equities index that tracks the stock prices of many of the companies listed on the Nasdaq exchange. Analysts use the Nasdaq to gauge the health of the stock market. It reflects investors' confidence in those companies and in the economy overall. Understanding the Nasdaq will help you understand how the stock market works.

What Does Nasdaq Stand For?

Nasdaq originally stood for the National Association of Securities Dealer Automated Quotation system. Nasdaq was founded in 1971. It introduced the world's first electronic stock market. It provided quotes for Over-the-Counter stocks not listed on other markets. As a result, it is associated in people's minds with technology stocks.

How Many Stocks Are in the Nasdaq?

Nasdaq lists stocks of over 3,800 companies. These include some of the most successful technology stocks: Apple, Microsoft, Alphabet (Google), Intel, Facebook, Amgen, Starbucks, and Tesla.

It also offers trading in derivatives, debt, commodities, structured products, and exchange-traded funds. 

Nasdaq Versus the Dow and S&P 500

The Nasdaq is an exchange, like the NYSE and the newly-created BATS. Unlike the NYSE, it also reports the performance of all the companies that it lists. 

The Dow, the S&P 500, and the MSCI are indices that track the performance of selected stocks. These three indices track U.S. stocks, so they pretty much trend together. But they weigh stocks differently. The Nasdaq uses total market capitalization. It simply takes the share price and multiplies it by the number of shares issued. It doesn't matter whether a company has split its stock or not.

Dow

The Dow is short for the Dow Jones Industrial Average or DJIA. It follows the stock prices of 30 companies selected by the editors of the Wall Street Journal to represent their industries. They tend to be large, well-known companies like General Electric and Kraft Foods.

The Dow weighs stocks with higher share prices more heavily than does the Nasdaq. That means the Dow's performance will be swayed by companies that haven't split their shares and consequently have maintained higher stock prices. 

S&P 500

The S&P 500 tracks the 500 most widely held stocks on the NYSE. The S&P 500 is broader. It gives a bigger representation of companies from various sectors and industry groups. Since it has more financial stocks than either the Nasdaq or the Dow, it hasn't performed as well as the other two since the 2008 financial crisis.

The S&P 500 also uses market capitalization, but only counts publicly available shares. This means that a company that has a lot of stock still held by a founding family member won't have as much sway.

MSCI

The MSCI is short for Morgan Stanley Capital International. It tracks stocks in global, frontier, and emerging markets. It also tracks other geographic sub-areas, such as the Gulf Cooperation Council, as well as global small-caplarge-cap, and mid-cap stocks.

Nasdaq Highs and Lows

The Nasdaq Composite reached a record high of 10,131.367 on June 23, 2020. It was set during a recession caused by the COVID-19 pandemic. Technology companies have been crucial to delivering information, video-connection, and products to residents locked-down during the pandemic. These companies will remain important to the economy even as states lift restrictions.

The Nasdaq Composite's prior record was 9,817.727 set on February 19, 2020.

Nasdaq Crashes

On August 22, 2013, Nasdaq shut down all trading from 12:14 p.m. EDT to 3:25 p.m. EDT. The flash crash was caused when one of the NYSE servers had trouble communicating with a server at Nasdaq. The server provided data about stock prices. Despite several attempts, the problem couldn't be resolved, and the stressed server at Nasdaq went down.

These flash crashes are not the same as a stock market crash. They don't have the power to cause a recession. They don't even last long enough to cause a market correction.

Nasdaq also had a problem with the Facebook IPO, the second-largest in history. On May 18, 2012, trading of Facebook's initial stock offering was delayed for the first 30 minutes. Traders could not place, change, or cancel orders. After the glitch was corrected, a record of 460 million shares were traded, creating $500 million in losses for traders. Nasdaq admitted it was caused by technical errors.

Nasdaq Bubble

On March 10, 2000, the Nasdaq reached its pre-recession high of 5,048.62. That was caused by the tech bubble. Irrational exuberance drove the prices of any type of tech or internet stock high above reasonable valuations.

The 2000 tech bubble was driven by the Y2K scare.

Most companies and many individuals bought new computer systems. They were afraid old software might not be able to transition from dates that started with "19" to dates that started with "20." Many software systems only recognized the last two digits of any year. Computer and software manufacturers warned everyone to update their computer systems so they wouldn't fail at the stroke of midnight in the new millennium. This caused sales to soar, which made it look like any tech-related company was sure to make a profit.

As it turned out, most computer systems were fine. Since everyone had just bought computers, demand was low, and orders for tech-related products plummeted. So did the Nasdaq, which dropped to 1,114.11 when it closed on October 9, 2002.

How the Nasdaq Affects the Economy

The Nasdaq affects the economy in the three ways outlined below.

Benefit to Small Investors

The Nasdaq allow small investors to own part of a successful technology company. Without Nasdaq and the other stock exchanges, only large private equity investors and financial institutions could profit from America's free-market economy.

Markets Help Savers Beat Inflation

Investing in the stock market helps savers beat inflation over time. Stocks generally provide greater long-term returns that the average rate of inflation. Stocks do have a greater risk than savings accounts because you could lose your principal.

Markets Help Businesses Fund Growth

Stocks also provide the capital for companies to grow large enough to gain competitive advantage through economies of scale. Growing, successful businesses need capital to fund growth. The stock market is a key source. In order to raise money this way, owners must sell part of the company. To do so they "take the company public" through an initial public offering (IPO) of the company's shares.

An IPO raises a lot of cash. It also signals that the firm is successful enough to afford the IPO process. The drawback is that the founders no longer own the company, the stockholders do. Founders can retain a controlling interest in the company if they own 51% of the shares.

Stocks indicate how valuable investors think a company is. When stock prices rise, it means investors believe earnings will improve. Falling stock prices mean investors have lost confidence in the company's ability to profit.

Stock prices rise in the expansion phase of the business cycle. Since the stock market is a vote of confidence, a crash can devastate economic growth. Lower stock prices mean less wealth for businesses, pension funds, and individual investors. Companies can't get as much funding for operations and expansion.

Article Sources

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