Dow Jones: A 137-year index that still acts as market development marker

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  • May 29, 2019, 16:3 AM
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Dow Jones Industrial Average (DJIA) or Dow 30 is an industrial index for the 30 largest U.S. industrial companies on the New York Stock Exchange and the NASDAQ. It was established on May 26, 1896, and is considered one of the oldest stock market indexes in the world.

The industrial index includes the top 12 American companies and the first added company was General Electric, where thereafter the number of listed companies have started to increase, reaching 30 companies in 1928. Among the latest companies listed in the index were Chevron and Bank of America on February 19, 2008.

History of Dow Jones

Dow Jones and Co. was established in 1882 by Charles Dow, Edward Jones and Charles Bergstresser. In 1884, Charles Dow formed his first average in stocks, which included nine railways and two industrial companies that appeared in the customer's afternoon message, a two-page Daily news bulletin that was presented to the Wall Street Journal.

On January 2, 1886, the number of shares represented in what is now the Dow Jones Transport index fell from 14 to 12, where the Central Pacific Railway and the Central Railway in New Jersey were removed. Although it had the same number of shares, this indicator included only one out of 12 industrial sectors that eventually formed the most famous Dow.

Charles Dow had a vision to create a standard that would expose the general market conditions, thus helping investors puzzled by the fractional dollar changes. It was a revolutionary idea at the time, but its implementation was simple. Averages were, well, normal old averages. To calculate the first average, Dow added stock quotes divided by 11-the number of shares listed in the index.

Dow Jones calculations

For calculating the DJIA, the total prices of all 30 shares are divided by divisor, which is Dow divisor. The divisor is adjusted in the case of stock splits, occasional changes, or similar structural changes to ensure that such events do not alter in themselves the numerical value of DJIA. Early on, the first divisor consisted of the original number of the constituent companies; This initially made DJIA a simple arithmetic average. The current divisor, after many modifications, is less than one (meaning that the index is greater than the total component prices).

You can calculate it by dividing the sum of the prices of the component stocks on the Dow divisor which was 0.14748071991788 till June 26, 2018. At the moment, each change in the price of one dollar in a given share within the average equals 6.781.

Dow Jones weighted average

The DJIA methodology is defined in the index calculation in the weighted way of the price: Companies are classified based on their share prices. In addition to having to deal with stock segmentation, the downside to this method is that it does not reflect the fact that changing one dollar for a stock worth $10 is much more important (percentage of wisdom) than changing one dollar for a share worth $100. Due to the problems associated with price weights, most of the other key indicators, such as the S&P 500, are calculated in terms of market value – that is, the companies are classified according to the number of existing shares that you own, multiplied by the value per share.

Accuracy of assessment

With only 30 currently listed shares, critics like Ric Edelman argue that DJIA is not a very accurate representation of the overall performance of the market. Still, it is the most martyred and most famous on a wide range of stock market indices. In addition, the Dow Jones Industrial Index is criticized for being a weighted average of the price, giving higher-priced equities more influence on average than their lower-priced counterparts, but does not consider the relative size of the industry or the market value of the components. For example, an increase of one dollar in lower-priced equities can be cancelled by a dollar low in equities with significantly higher prices, although lower-priced equities have experienced a greater percentage change. In addition, moving one dollar in the smallest component of DJIA has the same effect as the $1 movement in the largest component of the average. During the months of September and October 2008, the adjusted share price of the previous division of AIG collapsed from 22.76 dollars on September 8 to 1.35 dollars on October 27; contributing to a drop of nearly 3,000 points in the index.

Relationship between index components

A study between the relationship between the components of the Dow Jones Industrial Index compared to the index movement found that the correlation is higher during time periods in which the average decreases. The link is lower at times when the average is fixed or rises by a modest amount.

Summary

As a 137 years old index Dow jones is one of the most recognized market indices through the years, not only for its market performance assessment but also for its reflections to the shape of U.S economy, despite of its drawbacks.

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