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The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq. It is one of three major indicators of the movement of the U.S. stock market - the other two are the NASDAQ Composite and the Standard & Poor's 500. The Dow differs from the other two in that it is price-weighted - meaning a $1 price change in any stock affects the average the same way, regardless of whether the stock is priced at $5 or $500 per share. The NASDAQ and S&P indexes are weighted by market capitalization, which means a 1 percent change in any stock will impact the index just as much as a 1 percent change in any other stock, but the impact on the index of a $1 increase in a given stock's price will depend on how large a percentage increase it represents.
[edit] Composition of the Dow Jones IndexThe composition of the Dow Jones Industrial Average, as of September 22, 2008:[1] [edit] Pros and Cons of the Dow as an Economic Indicator[edit] Pro
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[edit] How does the Dow Jones Index work?Calculating the DJIA is not as simple as adding up the prices of the 30 stocks in it and dividing by 30. This is because of stock splits - if, for example, a stock trading at $50 dollars makes a 2-for-1 stock split, its shares would now be priced at $25. This would bring the price of the average down even though there was no fundamental change in the stock's value. To deal with this problem, the DJIA calculation is done using the Dow divisor.[3] [edit] The Dow DivisorTo calculate the DJIA, add up the prices of the 30 companies in the index and divide by the Dow divisor. This divisor is constantly changing due to events like stock splits. To illustrate how the Dow Divisor is used, let's create our own index of 10 stocks. These 10 stocks total $500 when their stock prices are added together - and to get the value of our new index, we divide the total price ($500) by the divisor (10) to give us an index value of 50 points. $500/10 = 50 points Now, one of our stocks (Stock A) does a 2-for-1 stock split. For the sake of the example, let's say that nothing else changed in our index - all the stocks remain at the same price, and Stock A that was trading at $50 is now trading at $25 after the split. So our index total has changed - $475 - but our divisor must change as well to take the split into account - it becomes 9.5. So we divide $475/9.5 and get 50 points. The point value of our index hasn't changed, which makes sense because the fundamental value of all of our stocks hasn't changed either. $475/9.5 = 50 points [edit] How do Changes in Stock Prices Impact the Dow Average?Translating a dollar change in one stock to a points change in the index is easy. Just divide the price change by the current divisor to get its effect on the index. Let's use Stock A again, trading at $25. It goes up $5 - so we divide this by 9.5 to get .5 points. So a $5 increase in Stock A's price would add .5 points to the value of our index. If all else stayed the same, the index would go to 50.5 points. [edit] An Example from the Actual MarketThe Dow Jones Divisor, as of July 30, 2008, was 0.122834016.[4] Dow component GE was up 2% on July 30 - $0.57 a share. So 0.57/0.122834016 = 4.64. The 2% rise in GE's stock price added 4.64 points to the Dow Average. The Dow was up 186.13 total points on July 30, as all but five stocks had percentage gains in their price on the day.[5] $0.57/0.122834016 = 4.64 points For more information, look at how stock indices work. [edit] Further ReadingFixing Dow Jones Index Flaws, Shoven & Sialm, 2/28/2000 [edit] References
Categories: Index | Topic | Major World Indices | Mature | Definitions |
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