There's practically no one that can escape hearing about how the stock market is doing. The numbers are announced in news broadcasts around the globe every day. In the United States often times people will talk about how the Dow Jones Average is doing. This is the average most quoted but actually professional traders will not spend much time with that number and focus most of their attention on the S&P 500. Why is that?

Stock indexes and averages are simply groupings of stocks put together to generate an indication of change within that grouping.  Since the stock market represents thousands of stocks, indexes and averages provide a quick overall gauge to direction the overall market is heading in.  Another important reason these indexes and averages exist are to give investors a method of measuring their performance against the overall markets.  

So we know why we have them but what's the difference between the two? (This gets a bit technical)
Stock Index - a time series of numbers used to calculate a percentage change of this series over any period of time.  The number is derived by using the market value of all stocks in the index relative to a base period.  A change in the market capitalization of a large company will have a greater impact on the value of the index than a comparable change in the market capitalization of a smaller company. This concept is referred to as value-weighted.  The S&P 500 is a value-weighted index.

Stock Average - an arithmetic average of the current prices of a group of stocks designed to represent the overall market or some part of it.  These stock averages are price-weighted meaning that the change in the average is related to the changes in the prices of their stock (not the market value of the company).  The Dow Jones Industrial Average is a price-weighted average.

More and more the Dow Jones Industrial Average (DJIA) has come under criticism for a few reasons.  Primarily, because there are very few companies that represented in the average and as such doesn't necessarily reflect the actual movement of the overall markets.  Because of this reason the DJIA isn't really meeting the expectations of being a true stock market average.

The other concern about the average is that it is price-weighted and not value weighted.  Since the prices of the stocks on the DJIA could trade in a large range when a higher priced stock moves it will affect the average more than and cheaper priced stock when in reality the actual price of the stock doesn't matter to investors.  In fact, there can be a lot more money made from cheaper stocks making only small moves but representing a larger percentage move.

Because of the downfalls of the DJIA there was a need to create a more representative measure of the broader market.  Many different indexes arose but the Standard & Poor's 500 Stock Composite Index is the most commonly used today.  It is the benchmark to which professional investors measure their performance.  It provides wide market coverage by including many stock over more sectors and calculates the index based on the value-weighted approach of their market capitalization.  By measuring stocks by their market capitalization, the larger companies have a larger effect on the value of the index instead of higher-priced stocks.

By understanding the differences between stock indexes and averages you will be able to better understand how the overall market is performing and why the Dow Jones averages are not necessarily the best indicators.  The difference between value-weighted and price-weighted calculations is not difficult but may not be initially obvious, but by understanding the difference between price and market capitalization it should be clear why the pro money manager choose to use the S&P 500.