What Is The Dow Jones Index And What Does It Measure?

Often referred to as “The Dow” or the “Dow Jones,” the Dow Jones Industrial Average is one of the oldest and most closely watched indices in the world and includes companies such as The Walt Disney Company, Exxon Mobil Corporation, and Microsoft Corporation. When the news networks say “the market is up today”, they are usually referring to the Dow Jones index.

Understanding The Concept Of The Dow Jones

The Dow Jones Industrial Average was designed to serve as a broad perspective on the US economy. When the index was released it only included 12 companies that were almost purely industrial. These companies operated the railroads, cotton, gas, sugar, tobacco, and oil. It is the second oldest index in the United States after the Dow Jones Transportation Average.

As the economy is constantly changing, so has the composition of this index. The Dow Jones typically makes changes when a company becomes less representative of the economy (for example, when it loses market capitalization due to financial difficulties) or when a broad economic change occurs and that change needs to be reflected in the index.

History

Precursors

In 1884, Charles Dow composed his first stock average, which contained nine railroads and two industrial companies that were featured in the Client’s Afternoon Letter, a two-page daily financial news bulletin that was the precursor to The Wall Street Journal. On January 2, 1886, the number of stocks represented in what is now the Dow Jones Transportation Average decreased from 14 to 12, as the Central Pacific Railroad and New Jersey Central Railroad were eliminated. Although it comprised the same number of stocks, this index contained only one of the original twelve industrials that would eventually make up the most famous Dow index.

Initial Components

Charles Dow calculated his first purely industrial stock average on May 26, 1896, creating what is now known as the Dow Jones Industrial Average. None of the original 12 industrialists are still part of the index.

These are the 12 companies that appeared in the first Dow Jones index:

1. American Cotton Oil Company, a predecessor company to Hellmann’s and Best Foods, is now part of Unilever.
2. American Sugar Refining Company, became Domino Sugar in 1900, now Domino Foods, Inc.
3. American Tobacco Company, divided in a 1911 antitrust action.
4. Chicago Gas Company, purchased by Peoples Gas Light in 1897, is now an operating subsidiary of Integrys Energy Group.
5. Cattle feed and distillation company, now Millennium Chemicals, formerly a division of LyondellBasell.
6. General Electric, still in operation, was removed from the Dow Jones Industrial Average in 2018.
7. Laclede Gas Company, still in business as Spire Inc, dropped out of the Dow Jones Industrial Average in 1899.
8. National Lead Company, now NL Industries, was removed from the Dow Jones Industrial Average in 1916.
9. North American Company, an electric utility holding company, was broken up by the United States Securities and Exchange Commission (SEC) in 1946.
10. Tennessee Coal, Iron, and Railroad Company in Birmingham, Alabama, was purchased by US Steel in 1907; US Steel was removed from the Dow Jones Industrial Average in 1991.
11. United States Leather Company, dissolved in 1952.
12. United States Rubber Company, changed its name to Uniroyal in 1961, merged with the private Goodrich Corporation in 1986, bought by Michelin in 1990.

How Is This Index Calculated?

The stocks with the highest prices have a greater weight in the index. Thus, a higher percentage change in these shares will have a greater impact on the final calculated value. When the Dow Jones was released, Charles Dow calculated the average by adding the stock prices of the twelve companies included in the index and then dividing by twelve, resulting in a simple average. Over time, there have been additions and subtractions to the index, such as acquisitions and divisions of companies that have had to be taken into account by the index, and where the arithmetical calculation is no longer simply enough.

This led to the introduction of the Dow Divisor, a default constant (although it can be changed if the need arises) that is used to determine the effect of a one-point move on any of the thirty companies that make up the index. There have been instances (components added or removed, company splits, etc.) when the divisor needs to change so that the value of the Dow Jones index remains consistent. The current divisor is

The key point about the Dow Jones is that it is not an arithmetic average of the thirty most representative companies, as the S&P 500 index is. Instead, it reflects the sum of the price of a market share for all its components, divided through the divider. Therefore, a movement of one point in any company in the market (included in the index) will move the index by an identical number of points.

Changes In The Index Over Time

The index grew to 30 companies in 1928 and has changed the number of companies included in it by a total of 51 times. The first change came just three months after the index was launched. In its early years, up until the Great Depression, there were many changes in its components. In 1932, eight companies within the Dow Jones were replaced. However, during this change, Coca-Cola Company and Procter & Gamble Co. were added to the index, two companies that are still part of the index in 2019.

The largest recent change in the Dow Jones took place in 1997 when four of the companies included in the index were replaced. Two years later, in 1999, four more companies were changed. The most recent index change took place on June 26, 2018, when Walgreens Boots Alliance, Inc replaced General Electric Company.

Investment Methods In The Dow Jones

Investing in the Dow Jones index is possible through index funds as well as through derivatives such as options contracts and futures contracts.

Investment And Listed Funds

The easiest way to indirectly invest in the Dow Jones Industrial Average is to buy an index fund that tracks its daily movement. A mutual fund or exchange-traded fund (ETF) can replicate, before fees and expenses, the performance of the index by holding the same shares as the index, in the same proportions. Some ETFs use leverage or short strategies to increase price movements.

Futures Contracts

In the derivatives market, the CME Group, through its subsidiaries, the Chicago Mercantile Exchange (CME) and the Chicago Board of Trade (CBOT), issues futures contracts; the E-mini Dow ($5) Futures (YM), which tracks the average and trades on their trading floors respectively. Trading is typically conducted at an open protest auction, or on an electronic network such as CME’s Globex platform.

Options Contracts

The Chicago Board Options Exchange (CBOE) issues option contracts on the Dow through the root symbol DJX. Options on various underlying Dow ETFs are also available for trading.

Important Historical Facts In The Dow Jones

The following are some of the most important historical events that have affected the Dow Jones:

May 26, 1896: The Dow Jones Industrial Average begins publication, listing 12 companies. At that time, the index registered 40.94 points.

October 24, 1929: Crash of 29, the Dow Jones index begins to fall from 400 points to 198 points in mid-November 1929

March 15, 1933: The largest one-day percentage gain in the index occurred during the bear market of the 1930s, totaling 15.34 percent. The Dow gained 8.26 points and closed at 62.10.

October 19, 1987: The largest one-day percentage drop occurred on Black Monday. The index fell 22.61 percent. There were no obvious explanations behind the event, although changing trading programs may have been a contributing factor.

September 17, 2001: The fourth-largest one-day point drop, and the largest at the time, took place on the first trading day following the 9/11 attacks on New York City. The Dow fell 684.81 points or about 7.1 percent. However, it is important to note that the index had been falling before 9/11, losing more than 1,000 points between January 2 and September 10. Despite this, the Dow began to gain strength after the attacks and recovered all that it lost, closing above the 10,000 mark by the end of the year.

September 29, 2008: The Dow Jones falls by 6.98%, with a drop of 777.68 points during the subprime mortgage crisis that affects Europe and the United States.

May 3, 2013: The Dow surpassed the 15,000 mark for the first time in history.

January 25, 2017: The Dow closed above 20,000 points for the first time.

January 4, 2018 – The index closed at 25,075.13, the first close above 25,000 points.

Jan 17, 2018 – The Dow closed at 26,115.65, the first close above 26,000 points.

February 5, 2018 – The Dow dropped a record 1175.21 points.

September 21, 2018: The index hit a record high of 26,743.50 points.

December 26, 2018 – The Dow posted its biggest one-day point gain ever at 1086.25.

July 12, 2019: The highest Dow Jones record to date at 27,332 points.

Recent Index History

On September 17, 2001, the first trading day after the 9/11 attacks, the Dow fell 7.1%. However, the Dow began trending higher shortly after the attacks and quickly made up all lost ground to close above 10,000 points for the year. In 2002, the Dow fell to a 4-year low of 7,286 on September 24, 2002, due to the 2002 stock market crash and the lingering effects of the dot-com bubble. Overall, while the NASDAQ fell about 75% and the S&P 500fell about 50% between 2000 and 2002, the Dow only fell 27% during the same period. In 2003, the Dow was stable within the 7,000 to 9,000 point level and recovered to the 10,000 mark by the end of the year.

The Dow continued to climb and reached a record high of 14,198.10 points on October 11, 2007, a mark that was not reached again until March 2013. It then fell over the next year due to the 2007-2008 financial crisis.

On September 15, 2008, a broader financial crisis became apparent when Lehman Brothers declared bankruptcy coupled with the economic effect of record oil prices that had reached nearly $150 a barrel two months earlier. The Dow lost more than 500 points for the day, returning to its mid-July lows below 11,000. A series of rescue packages, including the Emergency Economic Stabilization Act of 2008, proposed and implemented by the US Federal Reserve and Treasury Department did not prevent further losses. After nearly six months of extreme volatility during which the Dow experienced its largest single-day point loss, largest daily point gain, and largest intraday range (over 1,000 points) at the time, the index closed at a new 12-year low of 6,547.05 on March 9, 2009, its lowest close since April 1997. The Dow had lost 20% of its value in just six weeks.

By the second half of 2009, the average had rebounded toward the 10,000 level amid optimism that the late-2000s recession, the US housing bubble, and the 2007–2008 financial crisis were receding. and possibly coming to an end. Over the decade, the Dow saw a fairly substantial pullback for a negative return of 11,497 to 10,428 points, a loss of just over 9%.

Decade 2010 -2019

During the first half of the 2010s, aided by the Federal Reserve’s loose monetary policy, including quantitative easing, the Dow made a remarkable recovery attempt. This was despite significant volatility due to growing global concerns such as the 2010 European sovereign debt crisis, the 2009 Dubai World debt suspension, and the 2011 US debt ceiling crisis.

On May 6, 2010, the Dow lost 9.2% for the day and recovered almost all of it in a single hour. This event, known as Flash Crash 2010, generated new regulations to prevent future incidents.

Six years after its previous high in 2007, the Dow finally closed at a new high on March 5, 2013. It continued to rise over the next several years, over 17,000 points until a brief 2015-16 stock market sell-off in the second mid-2015. It then spiked in early 2016 and was up over 25,000 points on January 4, 2018.

The volatility returned in 2018 when the Dow fell almost 20%. As of early January 2019, the index had surged more than 10% from its Christmas Eve low.

Overall, in the 2010s, the Dow rose from 10,428 to 28,538 points for a substantial 174% gain.

Despite the emerging coronavirus pandemic, the Dow continued its bull run from the previous decade before reaching a high of 29,551.42 on February 12, 2020 (29,568.57 same-day intraday). The index retreats slowly for the rest of the week and into next week, before fears over the coronavirus and an oil price war between Saudi Arabia and Russia sent the index to new lows, posting several days of losses ( and earnings) of at least 1,000 points, a typical symptom of a bear market as seen earlier in October 2008 during the financial crisis. Volatility increased enough to trigger multiple 15-minute trading stops. In the first quarter of 2020, the DJIA fell 23%, its worst quarter since 1987

Criticism Of The Dow Jones

As a criticism, it can be said that the Dow Jones is quite restricted, as it only includes 30 companies and there are more than 15,000 companies on the stock market, so today it is not considered representative of the economic reality of the United States.

Another criticism is that the companies included in this index appear there for the value of their shares, but not for the size of the companies or their level of capitalization, so the index is highly speculative.

Companies That Make Up The Dow Jones Index

With information from Investopedia.