When people are talking about the stock market doing good or doing bad, they usually make reference to one indicator: The Dow Jones Industrial Average, better known as the Dow. It is the most recognizable and widely quoted indicator of the US stock market. Often when the markets are trending downward, news anchors and analysts speak about how many points the Dow lost during trading and vice versa. In July of 2019, the Dow went over 27,000 points for the first time as investors across the country cheered. So what exactly is the Dow Jones Industrial Average? What does it actually measure? Why is it measured in points and not dollars like every stock is?
What is the Dow Jones Industrial Average?
The Dow Jones Industrial Average is the average stock price of 1 individual share for 30 large US companies. How do they determine the 30 stocks? There is no hard and fast rule in determining what company is selected to make up the Dow. The only criteria used is if they are viewed as a leader in their industry and very large. These companies represent different market sectors with the exception of utilities and transportation. Utilities and transportation have their own indicator. Essentially, the Dow tries to show how the stock price of industry leaders across multiple market sectors are doing. It does not take into consideration the amount of shares that are outstanding or being traded, just the stock price.
What does the Dow measure?
It measures the price movement of US based large cap stocks. It can also give an indication on how the overall economy is doing over a long period of time. Using only the Dow to gauge the economy however, is often not a good idea. While the Dow looks at 30 very important US companies, the US stock market is comprised of around 19,000 different stocks, 4,000 of which are traded at a high volume. Generally, professional investors use other indicators along with the Dow to get an understanding on how the market is performing.
Why is the Dow measured in points?
The short answer is by making it a point system, it’s more simple to relay the information. When companies do share buybacks and stock splits, this can change the stock price, but not shareholder value. This can get tricky when trying to show the movement in stock prices. A company could be doing very well, split their stock 2:1, and lower their price by half. In order to avoid running into those issues, the Dow has a formula that used the average stock price divided by a factor known as the Dow divisor. Essentially, by using a points system, the Dow can take many different factors into consideration and show the price movement in a way that is easy for the average person to understand. When the Dow is gaining, points, the average stock price of the 30 companies is rising, and when it is losing points, the average stock price of those 30 companies is falling. It is possible for the Dow to be up and the overall stock market down. The Dow is not a good indicator for all investments. You should ask your adviser or consult the prospectus to see if the Dow is a good indicator for your investments.
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