Exploring Nasdaq: The Digital Stock Market Powerhouse (2024)

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• The Nasdaq is the world's largest electronic stock exchange with two closely watched indexes: the Nasdaq Composite and the Nasdaq 100.
• Technology, consumer services, and other growth stocks dominate the Nasdaq and have caused it to outperform other stock markets in recent years.
• The easiest way for individual investors to participate in the Nasdaq's volatile but high-performing stocks is through index funds.

The Nasdaq is the world's largest and oldest stock exchange where all of the buying and selling happens electronically, rather than on a physical trading floor.

Short for National Association of Securities Dealers Automated Quotations, the Nasdaq is the second-largest stock exchange globally based on the total market capitalization of its listed companies — exceeded only by the New York Stock Exchange (NYSE).

A pioneer in online operations when it launched in 1971, the Nasdaq provided a listing service for companies that had previously only traded over-the-counter (OTC). It quickly became the home for many new and innovative high-tech startups, including Microsoft and Apple.

To help you make sense of it all, here's what you need to know about the Nasdaq, from how it works to smart strategies for investing.

Introduction to Nasdaq

The Nasdaq was created in 1971 by the then-National Association of Securities Dealers (currently known as FINRA). Originally, the word Nasdaq was simply an acronym for National Association of Securities Dealers Automated Quotations.

In the beginning, the Nasdaq was just a quotation system — an electronic ticker of bid and ask prices — for over-the-counter (OTC) brokers to provide automated quotes for securities not available through exchanges. However, Nasdaq added trading and transactional systems over time. The list below contains key milestones in the history of the Nasdaq stock exchange:

• Intel went public on the Nasdaq in October 1971.
• Apple had its initial public offering (IPO) on the Nasdaq in December 1980.
• In 2004, Google Inc. went public on the Nasdaq.
• In 2005, Nasdaq, Inc. held an IPO, with shares trading under the ticker symbol NDAQ.
• In 2006, Nasdaq became a Securities and Exchange Commission-registered national securities exchange.
• In 2007, Nasdaq Inc. combined with the Scandinavian exchange group OMX to become the Nasdaq OMX group.

The Nasdaq does not have, and has never had, a physical trading floor. This became a problem for the exchange in 1995 as major companies such as Microsoft threatened to leave. No trading floor meant no physical presence, no opening bell ceremony, and, more importantly, no place for media networks to broadcast from during the trading day.

That problem was solved in 2000 with the opening of a massive 10-story tall tower at the corner of 43rd Street and Broadway in New York City, known as MarketSite, complete with video screens, a full television studio, and, yes, an opening bell ceremony. After this building debuted, the actual trading remained electronic.

It's a bit ironic: Nasdaq, which began as an all-electronic exchange, had to create a physical presence to gain greater credibility with Wall Street. But eventually, the New York Stock Exchange and other older, established exchanges, discovered the need for an electronic component in order to stay competitive in a rapidly evolving marketplace.

Nasdaq today

Today, the Nasdaq plays an important role in markets and the economy, with its two major indexes — the Nasdaq Composite Index and the Nasdaq 100 Index — closely watched barometers of business.

The Nasdaq is technically a dealer market where both buyers and sellers trade with a market maker in a particular stockor security, unlike an auction market (like the NYSE) where buyers and sellers trade with each other through a broker.

The Nasdaq's listed companies represent a broad range of sectors or industry groups. Most are in the fields of technology, consumer services, and health care.

While the Nasdaq has plenty of giant corporations, such as PepsiCo., PayPal, and Amazon, its stocks tend to be more growth-oriented, and less blue-chip, than those on the NYSE. Nasdaq equities have a reputation for innovation, disruption — and volatility.

How Nasdaq differs from other exchanges

Unlike other exchanges, the Nasdaq has never had a physical trading floor, a place where market participants could gather and execute trades. At first, all trades were made via telephone, until the crash that took place in 1987, named Black Monday, exposed weaknesses in this approach, which caused the Nasdaq to shift to an all-electronic system.

In the 1990s, the Nasdaq began harnessing electronic trading books called Electronic Communications Networks (ECN). As a result, the Nasdaq's systems were able to provide market participants with comprehensive information on the liquidity of stocks available for trade.

Due to the ongoing innovation of competing technologies, ECNs were forced to improve their functionality, which helped make the Nasdaq an environment characterized by continuous improvement.

As a result, Nasdaq has continued to focus on leveraging hardware and software to create an efficient marketplace for buyers and sellers.

Nasdaq and technology companies

The Nasdaq naturally attracts a large number of technology (and biotechnology) companies, which prefer the marketplace as a place to list their securities. Tech titans like Apple, Google and Intel all held IPOs on the exchange.

The Nasdaq draws these particular industry participants for multiple reasons. One key aspect is that it is easier to list on the Nasdaq than the NYSE, meaning that companies interested in having their shares trade there must meet less stringent requirements. This makes the Nasdaq more appealing to startups and other fledgling businesses.

Further, the fees for listing on the Nasdaq are lower.

Past that, the Nasdaq is more focused on growth stocks, and the shares of many different tech (and biotech) companies are more likely to cater toward investors seeking businesses with above-market growth prospects.

Another simple explanation is association. The Nasdaq is associated with technology firms in particular, meaning that many investors might consider it a go-to marketplace if they want to purchase shares of companies that derive their revenue and earnings from technology.

This might make it easier for any individual tech company looking to list on an exchange to get the attention of investors by listing on the Nasdaq.

The Nasdaq Composite Index

The Nasdaq isn't just a stock exchange. It also has two highly regarded indexes that track the performance of Nasdaq stocks daily. Knowing about these can be very helpful if you are researching investing in NASDAQ-listed companies.

The first of these is The Nasdaq Composite Index, which tracks most of the securities listed on the Nasdaq exchange — basically, everything but mutual funds, preferred stocks, and derivatives.

The Nasdaq is heavily weighted with technology stocks, making it a bellwether for the tech sector. As a result, the Nasdaq Composite is a widely followed barometer of the technology sector's financial health.

The second, smaller index is the Nasdaq 100, which focuses on the largest 100 companies traded on the Nasdaq. About six out of every 10 of them are in the tech sector.

The chart below provides additional detail on these indexes.

Source: Nasdaq data as of June 2024

Of the two, the Nasdaq Composite is the more influential. When commentators refer to "the Nasdaq closing up five points," it's usually the Composite they mean.

While the composite index is most widely followed, the Nasdaq 100 Index is more closely watched by traders and investors interested in futures, options, and exchange-traded funds (ETF).

Calculating the Nasdaq indexes daily average

Both the Nasdaq Composite and Nasdaq 100 Index use the same modified market capitalization weighting method in which the closing price of each share is multiplied by the total shares outstanding for that company to arrive at that stock's market capitalization.

Share weights are calculated by dividing each security's market capitalization by the total capitalization of all index securities. Share weights for each stock are then multiplied by that stock's closing price and the total divided by an index divisor that accounts for market fluctuations such as stock splits, mergers, and other actions. The result is the Nasdaq average for that day.

Performance of the Nasdaq indexes

Over time, Nasdaq stocks have tended to do better than the broader stock market. Its indexes — the Nasdaq 100 Index especially so — have historically outperformed the S&P 500 (which tracks large-cap stocks), and the Dow Jones Industrial Average (the 30 largest U.S. companies), two other stand-ins for the stock market overall.

For instance, the S&P 500 rose about 91.77% and the Dow gained about 65.6% in the five years through June 2024. During that same period, the Nasdaq Composite increased 136.17% while the Nasdaq 100 Index jumped 177.68%.

The explanation? Both Nasdaq indexes lean heavily into tech, consumer services, and health care — all top-performing industries in recent years.

However, remember that Nasdaq stocks also tend to be more volatile. That means they can fall much harder and faster during market downturns. That was seen in the first half of 2022, when both the Nasdaq Composite and Nasdaq 100 Index led the way lower as U.S. stocks tumbled into a bear market.

Impact of Nasdaq on the stock market

The Nasdaq has affected the overall stock market by being a leader in innovation and striving to create new technology designed for greater transparency and efficiency. Its strategy of focusing on using technology to create a market (as opposed to relying on a trading floor like the NYSE, for example) has made it a natural leader in terms of driving innovation.

Phil Mackintosh, chief economist for the Nasdaq, summed up these contributions nicely in an article that was released to coincide with the exchange's 50th anniversary in 1971.

"The story of Nasdaq's first five decades highlights its impact on trading today," he wrote. "The introduction of computers to markets, and sharing of quote data more widely, led to the automation of trading."

"With that automation came huge cost savings that, together with the internet, have democratized investing and helped the U.S. market stay the biggest, deepest and most cost-efficient market to list and trade in in the world," Mackintosh emphasized.

Nasdaq's role in market efficiency

The Nasdaq has helped bolster market efficiency through its focus on innovative technology. This exchange came into existence after the SEC encouraged the NASD to automate the market for OTC securities.

The infrastructure harnessed by the Nasdaq to create this market, as well as its prolonged focus on technological innovation, placed pressure on other exchanges to either evolve or get left behind. This development helped motivate rival exchanges to invest in their own innovation in order to keep up.

As automated systems have replaced manual labor, costs and errors have both fallen, according to Mackintosh. In addition, the rising use of technology in exchanges has coincided with greater transparency.

Challenges and criticisms

During its more than 50-year history, the Nasdaq has drawn some criticisms from market observers. The stocks listed on the exchange have experienced some substantial volatility, which has rubbed some the wrong way.

Sharp fluctuations are to be expected for the stocks on this exchange, given the marketplace's focus on tech stocks, which represent companies in a notoriously volatile sector.

These characteristics of volatility and a focus on tech stocks both factor into another Nasdaq-related development that has provoked judgment, more specifically the dot-com bubble of the 1990s and early 2000s.

This historical event coincided with a sharp increase in the value of stocks trading on the Nasdaq, followed by a crash. "In 1990, the value of stocks traded on the Nasdaq was 11% of the value of stocks traded on the New York Stock Exchange; in December 1999, the market value of Nasdaq was 80% of stocks traded on the NYSE," an article published on the Goldman Sachs website noted.

"The Nasdaq index rose 86% in 1999 alone, and peaked on March 10, 2000, at 5,048 units," the article added. Shortly after reaching this zenith, the aforementioned index crashed, falling more than 75% to reach 1,139.90 units in October 2022.

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