Introducing the DOW

Even if you don’t have a single dollar invested in the stock market, it’s pretty hard to ignore the recent headlines:

September 29 – The Dow looses nearly 770 points for lowest closing in five years

October 10 – The Dow continues to slide—down 128 points

October 15 – Dow down 733 points to 8,577—2840 points lost in one month

You don’t need to know exactly what the Dow is to conclude that this in not good news.

But what is the Dow? Why is there so much importance placed on its daily reports and why should we care?  First of all, Dow is short for Dow Jones Industrial Averages, or DJIA.  And two clues about what it actually is can be found in the words “industrial” and “averages.”

There are a variety of stock market averages listed in the financial news. The S&P 500 is the average value of 500 large companies. The Russell 2000 tracks the average stock prices of 2,000 smaller companies. And then there is the NASDAQ, the largest electronic screen-based equity securities trading market in the U.S. (More about that later.)

But by far, the granddaddy of all exchange indexes, the one most watched in good times and in bad, is the DJIA.  We thought a little Q. & A. would help you understand why this index gets so much attention.

Q. What is the DJIA?

A. The DJIA is a way of measuring the combined stock values of thirty blue chip U.S. companies. It’s become widely accepted that by following the daily price movements of these chosen companies, one can get an indication of how the market as a whole is performing.

To keep investors abreast of market conditions, the DJIA averages are calculated second-by-second throughout the trading hours. You can keep track using this excellent interactive chart.

History of the DOW

Q.  What’s the history of the DJIA?

A. Charles Dow, a journalist and founder of the Wall Street Journal, co-founded Dow Jones & Company back in the late 19th century and began research into daily market movements. At the time, there was no way to measure overall stock market performance. Individual stocks moved up slightly while others went down, but there was no snapshot indicator of whether Wall Street had experienced a good day or a bad one.

Dow began his index with a dozen stocks, mostly railroads.  Since railroads were the first major industrial corporations in the U.S., their stock prices were seen as an indicator of the growth of the economy—thus the word “industrial” first appeared in the index title.

Over time, the number of companies included in the index grew from twelve to twenty and eventually to thirty, where it still remains. When the index first launched, the average overall total at the close of trading was 40.94 points—a number that would have brought a smile to Charles Dow’s face if he’d been here on Oct. 9, 2007 when the DJIA broke an all time high of 14,165.43 points.

Q. How is the DJIA calculated?

A. Originally, the prices of single shares of each company's stock were added together and the total was divided by the number of companies to arrive at a simple average of the daily stock prices.

But today, there is a mathematical formula used to adjust for changes, such as when new companies are added or removed from the list, or when there are stock splits—this can occur when a share price becomes so high, the company doubles the number of stocks its shareholders own thereby splitting share price in half.  

To keep pace with the market’s growing complexity, the Dow now uses a weighted average that takes all those shifting factors into account.  Amazingly, it still gives an accurate overview of the market.

Since the index is based on the sales price of stocks, it uses a "price-weighted average," meaning that expensive stocks will have more influence over the final number than those that are priced lower.  In other words, if a high-priced share goes up 15 percent, that amounts to a greater dollar increase than when a cheaper share jumps by the same percentage.

The DJIA keeps the index relatively consistent over time so that today's value can be compared to what it was a year ago or even 10 years ago.  

Why the DOW is Important

Q. Why is the DJIA important?

A. It’s generally accepted that the DJIA has an impact on investor confidence.  Consider the financial crisis that began late September 2008.  When the news broke that major investment banks were in trouble, the market started to slide. Investors looked to the DJIA to see what other investors were doing.  When the charts indicated mass sell-offs, it had a snowball effect across the entire economy.

The less confidence investors have based on the numbers reflected in the DJIA, the less consumers spend, which leads to lower production, higher unemployment, and rather quickly, fear loops back to create further stock market declines.

In a less dramatic way, the DJIA is also a convenient tool for comparing the performance of your investments to the market as a whole. Maybe the over-all market slid 15 percent, but the total of your stock portfolio only fell by 5 percent.  It might lessen the sting, or it could work in reverse.

Q. What are the thirty companies listed on the index and how were they chosen?

A. Today, the thirty DJIA companies are all tops in their industries.  They represent nearly one-fifth of the $8 trillion market value of all U.S. stocks traded on all exchanges, and nearly one-quarter of all stocks traded on the New York Stock Exchange (NYSE).

The companies are chosen by the publication that Charles Dow founded—the Wall Street Journal. The editors periodically monitor these companies for any significant changes in their financial health.  For instance in September, AIG was removed from the list after the Feds took the control of the company.

The current companies are: 3M, Alcoa, American Express, AT&T, Bank of America, Boeing, Caterpillar, Chevron, Citigroup, Coca-Cola, DuPont, ExxonMobil, General Electric, General Motors, Hewlett-Packard, Home Depot, Intel, IBM, Johnson & Johnson, JPMorgan Chase, Kraft Foods, McDonald's, Merck, Microsoft, Pfizer, Procter & Gamble, United Technologies, Verizon Communications, Wal-Mart and Walt Disney.

Q. What’s the difference between the DJIA and the NASDAQ?

A. Both the DJIA and the NASDAQ refer to an index, or an average of certain stock prices.

NASDAQ is an acronym for the National Association of Securities Dealers Automated Quotations System, an electronic exchange where investors trade stocks. But when you hear reports that the NASDAQ is either up or down, it’s actually referring to the NASDAQ Composite Index, which, like the DJIA, is a measurement of part of the market.  

The NASDAQ Composite tracks the approximately 4,000 stocks traded on the NASDAQ exchange compared to the DJIA’s thirty stocks, most of which are traded on the NYSE.

The NASDAQ was developed in 1971 as a means to support the market for Over-the-Counter stocks, those that were unable to meet listing requirements for larger exchanges. It was the first electronic stock exchange in the world, and unlike the NYSE, has no physical trading floor with brokers racing around making deals, but rather facilitates all its trades through a computer and telecommunications system.