What is the Nasdaq and how does it work?

As you learn about investing, the Nasdaq is a common term you’ll hear, but what exactly is it? The term Nasdaq actually refers to both a stock exchange, where thousands of companies are traded, and a series of market indexes, such as the Nasdaq Composite and the Nasdaq-100, which measure the performance of those companies. 

Known for its heavy concentration in technology and growth stocks, the term "Nasdaq" is often used as shorthand for how the tech sector and innovation-driven companies are performing.

What is the Nasdaq? Exchange vs. indexes

Exchange

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The National Association of Securities Dealers Automated Quotations (Nasdaq) opened as the world’s first electronic stock exchange in 1971, offering automated price quotations, rather than traditional floor trading. During the 1980s, it became the preferred home for up-and-coming technology and growth companies, including Apple and Microsoft, which didn’t fit the mold of older, more established exchanges like the New York Stock Exchange (NYSE). 

As the growth of public tech companies surged, many of them listed on the Nasdaq, leading to the dot-com bubble in the late 1990s/early 2000s. Today, the Nasdaq is one of the world's largest stock exchanges, with over 3,000 listed companies. 

Indexes

Instead of looking at an individual company, a stock index measures the performance of a collection of stocks, usually representing a particular part of the market. The S&P 500 measures the 500 largest companies in the U.S. The Dow Jones Industrial Average (DJIA) tracks 30 large, publicly traded U.S. companies. Then, the Nasdaq has several different indexes, the most popular being the Nasdaq Composite Index and the Nasdaq-100 Index.

• Nasdaq Composite Index: Tracks more than 2,500 stocks listed on the Nasdaq exchange, including U.S. and international companies. Stocks in the index are weighted by market capitalization, which is determined by a company’s stock price multiplied by the number of shares it has. This means larger companies have more influence on the index than smaller ones. 

• Nasdaq-100 Index: This tracks the 100 largest non-financial companies listed on the Nasdaq. It’s known for its tech-heavy lineup, including companies like Nvidia, Apple, Microsoft, and Amazon. The Invesco QQQ exchange-traded fund (ETF) is one of the more well-known index funds that tracks this index. 

• Other Nasdaq indexes: Various indexes track different aspects of the Nasdaq, including sector-specific indexes, such as the Nasdaq Biotechnology Index, and location-based indexes, like the Nasdaq Emerging Markets Index. 

How to use the Nasdaq

Due to its high concentration of technology and growth companies, the Nasdaq also serves as a barometer that measures innovation and how it’s affecting the overall economy. When the Nasdaq is doing well, it typically suggests innovation is high and the economy is growing. 

Due to its high concentration of technology and rapid growth, the Nasdaq can also be more volatile than other benchmark indexes, meaning that its prices often fluctuate more rapidly. As a result, when it’s doing well, it can signal that investors may be more willing to take on risk in the current market. 

How Nasdaq indexes are calculated

• Market-cap weighting: The market caps of larger companies give them more influence in the index.

• Divisor adjustment: Ensures the index value remains consistent over time, regardless of stock splits or structural changes.

• Both price-return (just price movement) and total-return (includes dividends) versions exist.

How to invest in the Nasdaq

As with any stock market index, you can’t buy the index itself, but you can invest in the Nasdaq in a variety of ways, including ETFs, such as the QQQ for the Nasdaq-100 mentioned above, or mutual funds that track the Nasdaq Composite or Nasdaq-100. You can also typically find ETFs or mutual funds that track any Nasdaq index, depending on your investment goals. 

To invest, you need to open a brokerage account or retirement account, deposit money into the account, and choose which index funds or ETFs you would like to purchase. 

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Considerations for investing

As with any investment, there are pros and cons. How each could affect you depends on your personal situation, including how long you’re going to invest (time horizon), your risk tolerance, and your goals. Here are a few things to consider when investing in the Nasdaq:

• Concentration risk: The index is market-weighted, which means a few large tech companies dominate a majority of the shares, so it may not be as evenly diversified among companies as your portfolio requires. 

• Sector concentration: The Nasdaq is highly concentrated in the technology sector, which can mean extra risk if your overall portfolio is heavily focused on this sector and this segment of the stock market underperforms. 

• Balancing large and smaller companies: While indexes like the Nasdaq-100 are heavily concentrated in large companies, your investment objectives may call for exposure to smaller and mid-sized companies as well. You might also want to diversify into other asset classes, such as bonds, real estate, or cryptocurrencies. Consider which version of the Nasdaq index best fits your overall portfolio mix.

These factors don’t necessarily mean you should or shouldn’t invest in a Nasdaq index fund or ETF. Still, they’re worth considering as you determine how much of your portfolio to invest in the index (if at all). 

A key way to track innovation and growth

The Nasdaq is both a modern stock exchange and a benchmark for technology-driven companies. Its indexes, especially the Composite and Nasdaq-100, highlight the performance of some of the world’s most influential businesses. While more volatile than broader market measures, such as the S&P 500, the Nasdaq remains a key indicator of innovation and growth in today’s economy.

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