What is the Dow Jones?
The Dow Jones is a US sharemarket index which tracks 30 of the largest shares on the New York Stock Exchange (NYSE) and NASDAQ exchange.
Created by Charles Dow in 1896 with only 12 companies, 'The Dow' is often quoted in financial newspapers and on television.
The 30 companies included in the index are chosen to reflect the US economy. As a result, the companies rarely change as often as they might in other market indices, like the S&P 500, which includes the 500 largest US companies. The Dow index excludes companies in the utilities and transportation sectors.
Fun fact: General Electric has been included in The Dow since it first launched in 1896!
The Dow Jones is a price-weighted index.
What that means is the share with the highest price is given the most influence over the index's day-to-day movements.
For example, if a $1,000 share and a $10 share were both included in the index, the higher priced share ($1,000) would have a much larger influence on the index -- even if the company with a $10 share price had 200 times more shares on issue (making it a larger company).
When The Dow first launched, the formula was simply the price of all companies divided by 12. But with companies splitting their shares and mergers and acquisitions taking place, a 'divisor' had to be introduced. It adjusts by a small percentage every time one of these events happens, so The Dow's overall number of points is not unreasonably affected.
Nowadays, The Dow's formula is simply the price of all shares in the index divided by the 'Dow divisor', which is a number less than one.
In April 2017, the Divisor was 0.14602128057775. Meaning, a $1 share price movement results in The Dow moving (1/0.14602128057775) = 6.848 points.
Many of the most popular global market indices, such as Australia's ASX 200, London's FTSE 100, Hong Kong's Hang Seng and the USA's S&P 500 use market capitalisation to determine index inclusions.
Test Your Knowledge
'The Dow' is a type of Norwegian fruit. True or false.
As far as we know, Norway does not have a fruit called 'The Dow' (although, we only do finance - so we could be wrong). Typically, when you hear or read 'The Dow' or 'Dow Jones' it usually refers to the popular US stock market index.
How many companies are included in The Dow Jones Industrial Average?
The Dow started with just 12 companies but now has 30 constituents.
What is 'the Dow divisor'?
Fun fact: Mongolia is a landlocked nation. That means, it has no coast!
Why might an investor say the S&P 500 is a better measure of the US sharemarket than the Dow Jones? Because…
Most indices around the world use an adjusted market capitalisation (share price x the number of shares) so that the largest companies are represented in the index. By not taking into consideration the number of shares on issue, only including 30 companies and excluding two sectors, The Dow may not be as representative of the entire US sharemarket as, say, the S&P 500.
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