In the midst of weeks of stock-market chaos, a lot of concerned investors have tracked the Dow Jones industrial average daily trajectory like never in the past.
But only a small number comprehend how the calculation of the index of 30 of the biggest U.S. companies or what the stock market performance that is being so closely watched really means.
Here are some questions and answers that pertain to the world’s most well-known stock index.
What is the Dow Jones industrial average?
The Dow is the oldest ongoing U.S. market index, which is a method that is used to measure the combined stock values of 30 big US companies. It began with 12 components that included the companies that are now non-operational companies such as Tennessee Coal, Iron and Railroad, and US Leather. GE or General Electric is the only original component still around.
The index has extended to reflect the US economy’s departure from large industrial companies. Staples of the modern Dow Jones include massive financial companies like Citigroup, drug manufacturer Pfizer, and technology bellwether IBM.
How is it calculated?
Charles Dow launched the index way back in 1896, originally took the price of one share of each company’s stock, added the numbers up and then that number was divided by the number of companies. When the index launched the average was 40.94 — that’s a charming little number, especially when you compare that to Monday’s close of 9,387.61, or how about the Dow’s record high on Oct. 9, 2007 of 14,165.43.
These days, Dow Jones & Co. has a mathematical formula they use to adjust for certain things like stock splits, which is when a company doubles the number of stocks its shareholders have, which then splits the price of each in half , or new companies that have been added or removed.
The goal over time is to keep the index consistent and to make sure that the value today can be compared in a meaningful way to whether that comparison is from a year ago or a decade ago.
This can be carried out in a number of ways mathematically, but the Dow handles this with a change to the “divisor” — a number that is divided into the total of the stock prices. Currently that divisor stands at 0.122820114.
Why some components are larger than others?
The index is called a “price-weighted average,” meaning expensive stocks influence is higher over the number than lower-priced stocks. That’s because the index is based solely on the dollar value of stocks; when a high-priced share goes up 20%, that’s a bigger increase in dollar value than a less expensive share that jumps up 20%.
Let’s look at an example. Last week’s significant drop in the price in GM didn’t have a big effect on the Dow Jones, because GM’s stock was already really low. On Thursday, the stock fell 31% or $2.15, but it only lowered the Dow by 17.1 points. The drag on GM was not very obvious on a day when the Dow plunged 679 points.