The Dow Jones(DJIA) is an Outdated Antique.

You hear about the Dow Jones Industrial Average (DJIA) on nearly every major news station. It seems to be every economist’s favorite way to watch the market. What is it? How is it calculated? and Why is it no longer the best?

What is the Dow Jones?

It is one of the many Stock Market Indices used in the United States to guage total market performance.

The index was originally created by Charles Dow, cofounder of Dow Jones & Company- the Co. that produces the Wall Street Journal.

It was originally made to track the industrial sector of the market, hence the djIa.

The DJIA is composed of 30 of the largest companies in the United States. The only company to remain from the original 12 that made up the DJIA in 1896 is General Electric.

So how is it Calculated?

Its actually pretty simple.

The formula is very simple. You take the sum of all of the prices of the 30 stocks in the index and divide them by a divisor.

In 1896 the average was a pure average. In other words, it was the sum of the prices divided by 12, the number of companies in the DJIA.

The divisor is changing though. It changes, as companies in the DJIA go through situations like stock splits, in order to keep the value constant.

The divisor is currently 0.12283402. Because it is below 1, it yields a DJIA value that is larger than the sum of the prices in the index.

This doesn’t sound so bad?

It wasn’t in 1896. It was pretty cutting edge then.

You see- In 1896- there were no computers or calculators. So, the trading day would close at 4:00PM so that all of the bankers could sort out the day afterward, and the most that any index could really handle- find the prices for, add them up and divide- was about 30 different companies.

In modern day, with computers running the show for us, there is no need to limit our stock analysis at 30 stocks. With Indices like the Standard & Poors 500- analyzing 500 different companies – and the Wilshire 5000 – looking at 5000 different companies, the DJIA is simply not the most accurate way to follow the market any more.

So my advice?

Keep using it. Everyone else is. But dont use ONLY the DJIA.
Look at as many different indices as you can when guaging market performance.