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What is the Dow Jones Industrial Average? A full breakdown

At a glance:

  • Why was the Dow developed?

  • The Dow as a price-weighted average

  • How is the Dow calculated?

  • Which stocks are included in the Dow?

  • How do investors use the Dow?

  • Summary of the Dow Jones Industrial Average

Stock averages and indexes can help investors spot new trends and track long-term ones in the performance of various securities. The Dow Jones Industrial Average (^DJI) is the oldest of these market indicators.

Today we take it for granted and expect newscasters to include it in their regular weekday reports. Yet understanding "the Dow" in more detail can help us better understand the market itself and its potential to build wealth.

Why was the Dow developed?

Charles H. Dow created the first stock average in 1884, two years after he and Edward Jones formed Dow Jones & Company. The firm, located adjacent to the New York Stock Exchange, gathered stock prices daily, wrote reports by hand, and sent them via messenger to banks and other financial centers in the city.

Understanding the impact of the lists of daily price changes was a big challenge, until Dow developed the first average. This included nine railroad stocks and two additional companies.

The first industrial average

A dozen years later, the firm issued the first Dow Jones Industrial Average (^DJI), containing 12 companies—American Cotton Oil, American Sugar, American Tobacco, Chicago Gas, Distilling & Cattle Feeding, General Electric, Laclede Gas, National Lead, North American, Tennessee Coal & Iron, US Leather Preferred, and US Rubber.

Dow published the average in a daily financial bulletin that evolved into the Wall Street Journal.

The ups and downs of the Dow

The Dow's long history makes it a particularly useful comparison tool. Might you have guessed that the single worst year in the history of the Dow was 1931, when it declined more than 52 percent?

Perhaps you remember 1987. That year, the Dow broke 2,000 in January and then climbed to more than 2,700 in August, before the October crash. On Oct. 19, 1987, the Dow plummeted to 1,739, losing 508 points—a loss of almost 23 percent, the biggest daily percentage loss in the history of the Dow.

What were the best years? Number 1 was 1915, with an almost 82 percent increase. Number 2 was 1933, followed by 1928.

Today we take "the Dow" for granted and expect newscasters to include it in their regular weekday reports.*

The Dow as a price-weighted average

The Dow Jones Industrial Average began as a simple arithmetic mean computed by adding the trading prices of a group of securities and then dividing by the number of securities in the group. For instance, the first average price of industrial stocks in 1896 was 40.94.

By itself, this figure had little meaning. However, it became significant over time, as investors compared it to the average price a month, a year, or a decade earlier.

How it has changed over time

Today, the Dow is no longer a simple arithmetic mean. Instead of dividing by the number of stocks in the group, the divisor has been altered to compensate for stock splits and other situations. As a result, the Dow now is a price-weighted average.

A stock average also can be weighted for other factors, such as market capitalization (price multiplied by the number of shares outstanding). Sometimes, people refer to the different types of stock averages and indexes interchangeably, although they measure different things.

How a stock index differs from a stock average

In contrast to a stock average, a true stock index is figured in relation to an established base market value—in other words, at a particular point in time. For example, the Standard & Poor's 500 Composite Index measures current prices of 500 stocks against the base period of 1941–1943.

Stock averages and indexes can help investors spot new trends and track long-term ones in the performance of various securities. Understanding "the Dow" in more detail can help us better understand the market itself and its potential to build wealth.

How Is the Dow Jones Industrial Average Calculated?

The Dow Jones Industrial Average tracks the performance of 30 blue chip US stocks. Originally an average computed with pen and paper, the Dow has evolved over the years to take into account various changes in the market and individual stocks.

The Dow today doesn't simply add up the prices of its stocks and divide by 30. Instead, the divisor is altered to account for such changing factors as mergers, substitutions, stock dividends, and splits.

Why change the divisor?

The most common reason for changing the divisor is a stock split. If one of the 30 companies on the list issued a two-for-one split, each share would instantly be worth only half as much as before the split. Each shareholder would own twice as many shares, with each share worth only half as much as previously. This price reduction would distort the Dow, so the divisor is changed to compensate for the split.

Every time a stock split has occurred in the Dow's history, the divisor has been adjusted downward. The year 1986 marked the point at which the divisor fell below 1; the divisor was 0.147 in late September 2019.

The effect of dividing by a number less than 1 is to increase the result. An increase of $10 in the combined prices of the 30 stocks on Nov. 1, for example, would have resulted in a Dow rise of close to 50 points.

Remember, the Dow is not a simple arithmetic average. It is essentially the sum of 30 stock prices adjusted for splits and other situations.

Which stocks are included in the Dow?

With thousands of US stocks to choose from, how does Dow Jones pick which ones to include in the Dow Jones Industrial Average (DJIA)? The editors of the Wall Street Journal choose stocks that are widely held, frequently traded, and that are issued by well-established companies that are major players within their industries and have a history of successful growth.

The Dow Jones Industrial average is displayed on a screen after the closing bell at the New York Stock Exchange, (NYSE) in New York, U.S., April 10, 2018. REUTERS/Brendan McDermid
The Dow Jones Industrial average is displayed on a screen after the closing bell at the New York Stock Exchange, (NYSE) in New York, U.S., April 10, 2018. REUTERS/Brendan McDermid

What are they?

Currently, the Dow includes the following 30 stocks:

Dow Jones also offers several other stock indexes. The Dow Jones Utilities Average (^DJU) tracks the prices of 15 utilities, and the Dow Jones Transportation Average (^DJT) traces the prices of 20 transportation stocks. In addition, the company provides an international index—the Global Dow—which is then divided into portions representing different nations and industries.

The Dow Jones Industrial Average is no crystal ball. However, this weighted average of 30 US blue chip stocks does provide a reliable long-term view of the US stock market.

How do investors use the Dow?

Because of its long history, the Dow Jones Industrial Average (DJIA) can provide the best data anywhere on market changes over time. The Dow has become one of the factors that economists and financial analysts use to track the US economy.

Along with such indicators as Standard & Poor's Composite 500 Index, the Consumer Price Index, the Gross Domestic Product, labor statistics, and money supply statistics, the Dow can indicate the early stages of a change in direction of the US economy.

Use it with other indicators

Some people have used the Dow alone to attempt to predict swings in the stock market and the economy as a whole, but not always with success. Charles Dow, for instance, developed the Dow theory.

This theory states that a series of ups or downs in the market does not indicate a change in market direction until both the Dow Jones Industrial Average and the Dow Jones Transportation Average have both attained either new market highs or lows. No one, however, has reportedly confirmed this theory with repeated, precise, and accurate forecasts.

No indicator is perfect, however

Pinpointing the exact time that a major market swing will occur is difficult. While a variety of analytical models and strategies sometimes have had limited success in forecasting change, none are failsafe.

After all, stock market trading is motivated by psychological factors, such as investor confidence in the US economy, as much as by the general financial success of the combined companies. Yet investors can read and note the Dow as part of their general awareness of the present direction and strength of the market.

Summary of the Dow Jones Industrial Average

The Dow Jones Industrial Average is no crystal ball. But this weighted average of 30 US blue chip stocks does provide a reliable long-term view of the US stock market. Investors can read and note the Dow as part of their general awareness of the present direction and strength of the market.

Besides the Dow, many other stock averages and indexes exist—including the AMEX Composite Index, the NASDAQ Composite Index, the New York Stock Exchange Composite Index, the PSE Technology 100 Index, and the Wilshire 5000. Each provides useful tracking information on a market or portion of a market.

This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.

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