Beginner's Guide to Market Indices

Editor's note: This is a special excerpt from TheStreet.com Ratings' Ultimate Guided Tour of Stock Investing.

Every night on the evening news, you hear references to the two main stock market indices: the Dow Jones Industrial Average DJI and the S&P 500 Index SPX ("indices" is the plural of "index "). Now you ask, "Why are they so important that we need to hear about them every single night?"

Well, think of the Dow Jones and the S&P 500 indices as big thermometers for the market. That's right; they actually take the temperature of the stock market so you know its condition. A market index is a group of stocks that share some common characteristics. It's an important tool, because it helps you figure out how your stock is doing compared with its peers. So you've got to use the right one to take your stock's temperature. Let's start by looking at the various thermometers, or indices, that are available.

For example, the S&P 500 is a group of 500 stocks chosen by Standard & Poor's because they have common characteristics, such as their size and popularity, and make up a good representation of the entire stock market. So if you want to know if a stock performs better, or worse, than the overall market, you check this index. You also may check "The Dow," because this index is made of stock from the 30 largest U.S. companies, which drive the economy, and therefore, many forecasters believe, reflect a pretty accurate picture of the market.

Two exchange-traded funds (ETFs) that track the performance of the Dow Jones and the S&P 500 are the Diamond Trust, Series 1 DIA and the SPDR ("Spider") Trust, Series 1 SPY.

If the indices appear to be enjoying a positive return on a regular basis and the economic news is sunny, the stock market is enjoying prosperity. But if, on a regular basis, the indices are showing trouble night after night, you may want to investigate where the trouble is coming from. Remember, a down market can pose a buying opportunity, or it could be a warning sign of more to come.

You have to investigate further and find out if the reason is temporary or here to stay. That's when investors use additional economic information from several sources to investigate. Much investigation involves looking at different aspects of consumer spending, which drives two-thirds of the U.S. economy. These bits of the puzzle can offer clues about how your stock may do under these conditions.