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Nasdaq

What Is NASDAQ?

NASDAQ, an acronym originally standing for the National Association of Securities Dealers Automated Quotations, is a global electronic marketplace for buying and selling securities. It operates as a major component within the broader category of stock market & exchanges, playing a pivotal role in global finance. Founded as the world's first fully electronic trading system, NASDAQ revolutionized how stocks are traded by moving away from traditional physical trading floors. Today, it stands as the second-largest stock exchange in the United States by market capitalization of listed companies, known for its strong focus on technology and growth-oriented firms.,43 NASDAQ, Inc. also owns and operates multiple other exchanges and clearinghouses globally.

History and Origin

NASDAQ's origins trace back to the National Association of Securities Dealers (NASD), now known as the Financial Industry Regulatory Authority (FINRA)., The U.S. Securities and Exchange Commission (SEC) encouraged NASD to automate the over-the-counter (OTC) market, which at the time involved manual, telephone-based trading and was often inefficient.,42,41 This initiative led to the launch of the NASDAQ Stock Market on February 8, 1971.

Initially, NASDAQ functioned primarily as a quotation system, providing real-time bid and ask prices from market makers to brokers across the country.,40 This was a significant advancement, enabling more efficient price discovery compared to the fragmented OTC market.39 While trading initially still relied on telephones, NASDAQ continually evolved its technology.38 The rapid adoption of NASDAQ's electronic model influenced market structures worldwide, making computerized trading the standard.,37 In 2002, NASDAQ, Inc. became a publicly traded company itself, listing its own shares on the exchange under the ticker symbol NDAQ. By 2006, its status officially transitioned from a stock market to a licensed national securities exchange. The exchange's commitment to technological advancement has been a cornerstone of its development.36

Key Takeaways

  • NASDAQ is the world's first fully electronic stock market, established in 1971, which transformed securities trading.,
  • It is known for listing a high concentration of technology and growth companies, though it hosts diverse sectors.35,34
  • The NASDAQ Composite Index is a widely followed stock market index that tracks nearly all stocks listed on the NASDAQ exchange.33,
  • NASDAQ operates as a dealer market, where multiple market makers compete to facilitate trades, differing from the auction market model.32
  • Companies seeking to list on NASDAQ must meet specific financial, liquidity, and corporate governance standards.31,

Formula and Calculation

The NASDAQ Composite Index is a market-capitalization-weighted index, meaning that companies with larger market capitalizations have a greater impact on the index's value.30,29 The calculation involves summing the product of each security's closing price and its index share weight, then dividing by an index divisor. This divisor is adjusted periodically to account for events such as stock splits, dividends, or changes in the index's constituents, ensuring continuity and comparability of the index value over time.28

The basic formula for a market-capitalization-weighted index value is:

Index Value=∑(Share Price×Shares Outstanding)Divisor\text{Index Value} = \frac{\sum (\text{Share Price} \times \text{Shares Outstanding})}{\text{Divisor}}

Where:

  • Share Price represents the current market price of each security in the index.
  • Shares Outstanding refers to the number of common shares a company has issued that are held by investors. The product of Share Price and Shares Outstanding gives the market capitalization for each company.
  • Divisor is a numerical value used to maintain the continuity of the index's value when events like stock splits or additions/deletions of companies occur, preventing these events from artificially distorting the index.

The NASDAQ Composite Index is continuously calculated throughout the trading day, with its value updated every second during market hours.27,26

Interpreting the NASDAQ

Interpreting the NASDAQ involves understanding its composition and how its movements reflect broader market sentiment, particularly within the technology sector. The NASDAQ Composite Index is heavily weighted towards technology companies, including many of the world's largest tech giants.25, Therefore, significant movements in the NASDAQ often signal trends in the technology and growth sectors.

For investors, a rising NASDAQ Composite can indicate strong performance and investor confidence in innovative companies. Conversely, a declining NASDAQ may suggest a pullback in growth stocks or a broader market correction, especially affecting companies reliant on future earnings potential rather than immediate profitability. Understanding the specific market segments within NASDAQ, such as the NASDAQ Global Select Market and NASDAQ Global Market, can also provide insight into the types of companies performing well or facing challenges.24,23 Given its focus on innovation and growth, NASDAQ-listed companies can sometimes exhibit higher volatility compared to those on more traditional exchanges.22

Hypothetical Example

Imagine "GreenTech Innovations Inc.," a rapidly growing startup specializing in sustainable energy solutions, decides to go public through an initial public offering (IPO) on NASDAQ. After meeting NASDAQ's stringent listing requirements, GreenTech Innovations Inc. is approved. On its first day of trading, the company's shares open at $25 per share.

As the trading day progresses, positive news about a new GreenTech project boosts investor confidence, leading to strong buying interest. The high demand for GreenTech's shares attracts several market makers to quote competitive prices, contributing to the stock's liquidity. By the end of the day, GreenTech's stock closes at $32, reflecting a significant increase. This daily movement contributes to the overall calculation of the NASDAQ Composite Index, with GreenTech's market capitalization now playing a role in the index's performance.

Practical Applications

NASDAQ's practical applications extend across various aspects of the financial world:

  • Investment Benchmarking: Investors and fund managers frequently use the NASDAQ Composite and NASDAQ-100 indexes as benchmarks to measure the performance of technology-focused portfolios or growth strategies. Exchange-Traded Funds (ETFs) and mutual funds are often designed to track these indexes, providing investors with diversified exposure to NASDAQ-listed companies.21,
  • Capital Raising: For emerging and established technology, biotechnology, and growth companies, NASDAQ serves as a primary venue for raising capital through stock offerings. Its reputation as a tech-friendly exchange attracts many innovative firms seeking public financing.20
  • Market Analysis: Financial analysts closely monitor NASDAQ trading volume, price movements, and trends in its constituent sectors to gauge investor sentiment and economic health, particularly regarding technological advancements and innovation.
  • Regulatory Oversight: The Securities and Exchange Commission (SEC) closely oversees NASDAQ's operations and its listed companies, ensuring compliance with securities laws and maintaining fair and orderly markets. NASDAQ itself implements and enforces its own marketplace rules and corporate governance standards for listed entities. Regulators like the Federal Reserve also monitor activities on exchanges like NASDAQ for their broader implications on financial stability and monetary policy. The Federal Reserve influences financial conditions through monetary policy, affecting interest rates and the money supply, which in turn can impact stock market activity on exchanges such as NASDAQ.19,18

Limitations and Criticisms

Despite its prominence, NASDAQ faces certain limitations and criticisms. Its heavy concentration in the technology sector can lead to increased volatility compared to more diversified indexes.17 For instance, during periods like the dot-com bubble in the late 1990s, the NASDAQ Composite experienced rapid surges followed by steep declines. This concentration means that market-wide downturns, or specific sector-related issues, can disproportionately impact the NASDAQ.

Another area of criticism relates to technical glitches, which, while infrequent, can disrupt trading. For example, in March 2024, NASDAQ experienced a technical glitch that impacted premarket trading for over two hours, highlighting the reliance on complex electronic systems.16 Such incidents can lead to uncertainty and a temporary lack of liquidity for affected securities.

Furthermore, companies listed on NASDAQ must adhere to ongoing listing requirements to maintain their status. Failure to meet these criteria can result in delisting from the exchange, which can negatively impact a company's stock price and investor confidence. The exchange has also faced scrutiny regarding the presence of low-priced stocks, leading to efforts to tighten rules to purge potentially risky "penny stocks."15

NASDAQ vs. New York Stock Exchange (NYSE)

NASDAQ and the New York Stock Exchange (NYSE) are the two largest stock exchanges in the United States, yet they operate on fundamentally different models.

FeatureNASDAQNew York Stock Exchange (NYSE)
Trading ModelDealer Market (Electronic)Auction Market (Hybrid: Electronic & Floor-based)
ExecutionTrades executed electronically through competing market makers.14,13Trades facilitated by designated market makers (specialists) on a physical trading floor, supplemented by electronic trading.,
Company FocusHistorically, strong focus on technology, biotech, and growth companies.12Historically, known for older, more established, and larger blue-chip companies and industrial firms.11
Market CapitalizationSecond largest U.S. exchange by market capitalization.Largest U.S. exchange by market capitalization.
Physical LocationEntirely electronic; no physical trading floor.10Has a historic trading floor on Wall Street, although most trading is electronic.9
Listing FeesGenerally considered less expensive to list on NASDAQ.8Typically higher listing fees.7

The primary source of confusion often stems from the different trading mechanisms. NASDAQ's dealer market involves multiple dealers (market makers) continuously updating bid and ask prices, and investors trade with these dealers.,6 In contrast, the NYSE's auction market model involves buyers and sellers submitting competitive bids, with transactions occurring when the highest bid meets the lowest ask.,5 While the NYSE has a physical trading floor, the vast majority of trades on both exchanges are now executed electronically.4

FAQs

What does NASDAQ stand for?

NASDAQ originally stood for the National Association of Securities Dealers Automated Quotations. While no longer an acronym in daily use, it refers to the exchange and the company that operates it.

What types of companies are typically listed on NASDAQ?

NASDAQ is well-known for listing technology, biotechnology, and other growth-oriented companies, including many prominent global firms. However, it also lists companies across various other sectors, such as healthcare, financial services, and consumer goods.3,2

How does NASDAQ compare to other major stock exchanges?

NASDAQ is unique due to its entirely electronic trading system, a pioneering feature when it was founded. While it is the second-largest U.S. stock exchange by market capitalization, it often has the highest trading volume. Its focus on growth companies distinguishes it from older exchanges like the NYSE.,1

Can individual investors directly trade on NASDAQ?

Individual investors do not directly trade on the NASDAQ exchange. Instead, they access NASDAQ-listed securities through brokerage firms, which then route their buy or sell orders to the exchange.

What is the NASDAQ Composite Index?

The NASDAQ Composite Index is a stock market index that includes almost all of the common stocks listed on the NASDAQ Stock Market. It is a market-capitalization-weighted index, meaning larger companies have a greater influence on its value, and it serves as a key indicator of the performance of technology and growth stocks.