Dow Jones Industrial Average

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Created in 1896, the Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 of the largest, most liquid NYSE and NASDAQ listed stocks. The DJIA is not limited to traditionally defined industrial stocks. Instead, the index serves as a measure of the entire U.S. market, covering such diverse industries as financial services, technology, retail, entertainment and consumer goods.

Daily values of Dow Jones indexes, distributed via major real-time and end-of-day market-data vendors, are published in financial publications and on financial Web sites.

The Dow Jones Industrial Average is maintained and reviewed by editors of The Wall Street Journal. Changes in index composition are infrequent and generally occur only after corporate acquisitions or other dramatic shifts in a component's core business. When such an event requires that a component be replaced, the full index is reviewed. As a result, multiple component changes are often implemented simultaneously.

There are no rules for component selection, but a stock typically is added only if it has an excellent reputation, demonstrates sustained growth, is of interest to a large number of investors and accurately represents the sector(s) covered by the average. Only one of the original 12 DJIA stocks is in the index today.

History

When Charles H. Dow first introduced his industrial stock average as a 12-stock index on May 26, 1896, the stock market was not highly regarded. Prudent investors bought bonds, which paid predictable amounts of interest and were backed by real machinery, factory buildings and other hard assets.

The Dow Jones Industrial Average played a role in bringing about this tremendous change. One hundred years ago, even people on Wall Street found it difficult to discern from the daily jumble of "up-a-quarter" and "down-an-eighth" whether stocks generally were rising, falling or treading water. Charles Dow devised his stock average to make sense out of this confusion. He began in 1884 with 11 stocks, most of them railroads, the first great national corporations. He compared his average to placing sticks in the beach sand to determine, wave after successive wave, whether the tide was coming in or going out. If the average's peaks and troughs rose progressively higher,then a bull market prevailed; if the peaks and troughs dropped lower and lower, a bear market was on.

It seems simplistic nowadays with myriad market indicators, but late in the Nineteenth Century it was like turning on a powerful new beacon that cut through the fog. The average provided a convenient benchmark for comparing individual stocks to the course of the market, for comparing the market with other indicators of economic conditions, or simply for conversation at the corner of Wall and Broad Streets about the market's direction.

The mechanics of the first stock averages were dictated by the necessity of computing it with paper and pencil: Add up the prices and divide by the number of stocks. This application of grade-school arithmetic, while creative is hardly worthy of remembrance more than a century later. But the very idea of using an index to differentiate the stock market's long-term trends from short-term fluctuations deserves a salute. Without the means for the ordinary investor to follow the broad market, today's age of financial democracy (in which millions of employees are actively directing the investment of their own future pension money and as a result are substantial corporate shareholders) would be unimaginable.

Following the introduction of the 12-stock industrial average in the spring of 1896, Dow, in the autumn of that year, dropped the last non-railroad stocks in his original index, making it the 20-stock railroad average. The utility average came along in 1929 (more than a quarter-century after Mr.Dow's death at age 51 in 1902) and the railroad average was renamed the transportation average in 1970.

At first, the average was published irregularly, but daily publication in The Wall Street Journal began on Oct. 7, 1896. In 1916, the industrial average expanded to 20 stocks; the number was raised again, in 1928, to 30, where it remains today. Also in 1928, the Journal editors began calculating the average with a special divisor other than the number of stocks, to avoid distortions when constituent companies split their shares or when one stock was substituted for another. Through habit, this index was still identified as an "average."

The 30 stocks now in the Dow Jones Industrial Average are all major factors in their industries, and their stocks are widely held by individuals and institutional investors. The DJIA accounts for approximately 23.8% of the total U.S. market, as measured by the Dow Jones Wilshire 5000 Index, as of December 13,2005. [1]

In 1999, the inclusion of Intel and Microsoft was big news, as it marked the first time in history that non-New York Stock Exchange issues had been added to the Dow index.

In January of 2011, the Dow Jones Industrial Average passed the 12,000 mark for the first time since June 17, 2008. This was positive news about new home sales and unemployment claims, which pushed traders into a buying mood. [2]

Notable Milestones (at close) for the DJIA:

  • 15,000: May 7, 2013
  • 14,000: July 19, 2007
  • 13,000: April 25, 2007
  • 12,000: October 19, 2006
  • 11,000: May 3, 1999
  • 10,000: March 29, 1999
  • 9,000: April 6, 1998
  • 8,000: July 16, 1997
  • 7,000: February 13, 1997
  • 6,000: October 14, 1996
  • 5,000: November 21, 1995
  • 4,000: February 23, 1995
  • 3,000: April 17, 1991
  • 2,000: January 8, 1987
  • 1,000: November 14, 1972

DJIA Calculation

The DJIA, unlike some other indexes, are unique in that they are price weighted rather than market-capitalization weighted. Their component weightings are affected only by changes in the stocks' prices, in contrast with other indexes' weightings that are affected by both price changes and changes in the number of shares outstanding.

When the averages were initially created, their values were calculated by simply adding up the component stocks' prices and dividing by the number of components. Later, the practice of adjusting the divisor was initiated to smooth out the effects of stock splits and other corporate actions.

The current divisor value for DJIA is: 0.123017848

Strengths and Weaknesses

Strengths

The continual focus on mega-cap companies, the names of which are all of which are highly recognizable to investors, provides the DJIA with the distinction of being the most frequently known index. When investors ask "What did the market do today?", they are referring to the DJIA.

Weaknesses

Because it is restricted to just 30 U.S. companies, the DJIA is not diverse. Though it does not focus solely on industrial companies as its name would imply (though long ago that would have been accurate), it does not accurately reflect the performance of other important pieces of the U.S. or global marketplaces. Additionally, it is price weighted, and thus does not track the actual performance of the listed index companies in a way that reflects a rational investor's gains. To equal the Dow's performance, an investor be required to purchase the same number of shares of each component company; such a strategy would force the investor to invest more money in companies with higher share prices.

Financial Instruments "Born" from DJIA

Dow Jones, like Standard & Poor's and the Russell organization, is a licensing machine. It has been extremely proactive in marketing the DJIA Index (and a whole host of other Dow Jones indexes) as a "commodity" among various financial exchanges. The exchanges have capitalized on the name by creating financial instruments based on the index. Those include:

Index Exchange Symbol
DJIA Exchange Traded Funds (ETFs) on "Diamonds" AMEX (DIA)
DJIA Options Chicago Board Options Exchange (DJX) (MUT)
DJIA Options on Diamonds Chicago Board Options Exchange (DIA)
DJIA Exchange Traded Fund Dow Jones Master Unit Euronext (DJE)
DJIA Futures (ZD/DJ) and options on futures (OZD/DJC--calls; DJP--puts) CME Group ***
DJIA Mini-Dow futures CME Group (YM/YJ)

Indexes and Licenses

The DJIA is one of 10,000 Dow Jones indexes. A number of exchanges worldwide have licensee agreements with Dow Jones to trade financial products based on these indexes. See above for just one example.

Recent News

Before the open on Tuesday, September 10, 2013, an announcement was made that Goldman Sachs Group Inc., Visa Inc. and Nike Inc. would be joining the Dow Jones Industrial Average. Bank of America Corp., Hewlett-Packard Co. and Alcoa Inc. were announced to have left. This represented the first "three-for-three" change to the blue-chip index since April 8, 2004.[3]

On May 26, 2011, the Dow Jones Industrial Average celebrated its 115th birthday.[4]

  • Dow Jones Industrial Average biggest single-day jump: 499.19 points, March 16, 2000
  • Dow Jones Industrial Average biggest single-day drop: 684.81 points, September 17, 2001

References

  1. Dow Jones Indexes. Dow Jones.
  2. Dow Jones Industrial Average Tops 12000. ABC.
  3. Goldman, Visa, Nike will join Dow industrials. MarketWatch.
  4. Happy birthday to the Dow. MSN Money.

Dow Jones Indexes Motley Fool Index Center

See Also