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What Is the Dow Jones Industrial Average?

What Is the Dow Jones Industrial Average

This index shows the trading history of 30 companies on the stock exchange.

  • The Dow Jones Industrial Average is a group of stocks that represents the top 30 publicly-owned companies in the U.S.
  • The DJIA’s performance is directly tied to social and political events. For example, in March 2020 when the COVID-19 pandemic hit, the DJIA dropped a record 3000 points.
  • The DJIA is criticized by critics who argue that the index doesn’t represent all publicly traded companies.– Charles Dow, Wall Street Journal editor, created the Dow Jones Industrial Average (DJIA), a stock market indicator. The average was established on May 26, 1896. It is named after Edward Jones and Wall Street Journal editor Charles Dow. This index tracks the trading activity of 30 large U.S. publicly-owned companies during a normal trading session on the stock market.

Around 20 of the DJIA’s 30 component companies include industrial and consumer goods producers. Other industries include entertainment, financial services and information technology. The DJIA is only one of the Dow Jones market indexes.

History of DJIA

The DJIA started with 12 stocks, which eventually grew to 30. These stocks were American Cotton Oil, American Sugar, American Tobacco, National Lead, and Tennessee Coal, Iron, and Railroad Co.

The DJIA was launched on May 26, 1896. However, it didn’t appear in the Wall Street Journal until October 7, 1896. The DJIA’s starting point was 40.94. This is a far cry of the average 13,000 points in October 2012.

The stock market was not a well-known or popular way to invest money at the time. Bonds were the most popular form of investment because they were backed with real machinery, factories, and other tangible resources. The average American couldn’t tell if the stock market was in good health or bad.

Dow developed this stock average in order to make it easier to understand the stock market. He compared his average to putting sticks in the sand to see if the tide was rising or falling. A bull market is one that has peaks and valleys rising, and one that has troughs and drops falling.

The DJIA and the rest of the stock exchange were both heavily affected by war and politics. Major changes were triggered by a number of global events:

  • Fear of World War I led to trading being suspended for nearly 4.5 months. This resulted in a DJIA decline of almost 25% when trading was reopened.
  • The DJIA was almost 90% lower than its peak after 1929’s stock market crash and the subsequent Great Depression. [Read similar article: What is a Recession? ]
  • The DJIA fell 10% in the period of four months that Egypt seized the Suez Canal in 1956, which triggered an invasion by Israel, England, and France.
  • The DJIA fell nearly 508 points or 22.6% in 1987’s Black Monday crash.
  • The markets were closed on Sept. 11, 2001, following the terrorist attacks in New York City and Washington, D.C. The DJIA fell nearly 685 points or 7.13% when the markets reopened on September 17. Find out how the SBA supported small businesses by providing low-interest loans.
  • The DJIA suffered its largest drop on March 9, 2020. It fell to close to 3,000 points when the COVID-19 pandemic struck the United States. In March, the Dow dropped two more times. This was the third-worst three-point drop in DJIA history.

How to Join the DJIA

The editors at The Wall Street Journal take into account a variety of factors when choosing companies to represent an industry within the DJIA. They choose companies that are leaders in the market. How many years has the company been in existence? How do shareholders are treated? How is the company regarded in the industry? Wall Street Journal editors look for companies that are both relevant and not too trendy. They want to see the industry’s staying power.

One example of the logic that was used to determine the DJIA companies was when Philip Morris Companies purchased out DJIA component General Foods. This happened in 1985. Since American Brands already existed, the addition of Philip Morris to DJIA increased the number of companies that were represented. The editors decided to drop American Brands in favor of McDonald’s.

How the DJIA operates

The DJIA provides a clear picture of the stock market and, in turn, reflects the U.S. economic state. The index is calculated by adding 30 stocks to the average price and then dividing it by a divisor. Over the years, the divisor has decreased to compensate for arbitrary events such as stock splits or roster changes.

The index itself is price-weighted. This means that each company accounts for a proportion of the average. Stocks with higher prices are given more weight in an index than those with lower prices. This is why the price-weighted designation was created.

Although the Dow value does not reflect the average price of all its components stocks, it is consistent enough to generate an index value. The DJIA’s price is determined by many transactions. This increases market accuracy because it is composed of large, often traded stocks. Other indexes may have less traded stocks, which can lead to a lower average.

There are many uses and applications of the DJIA.

  • The DJIA monitors market conditions and allows investors to identify general trends and make better investment decisions.
  • The DJIA is a measure of future stock holdings, mutual fund and exchange-traded fund performance relative to the index’s performance.
  • Investors can examine correlations over time because the DJIA has been mapped so long.
  • Directly investing in the DJIA will allow you to build a portfolio.
  • The DJIA is a useful benchmark for evaluating other portfolios or individual investments. For example, a strong portfolio would outperform DJIA.

Criticism of DJIA

Many critics believe that 30 stocks are not representative of the entire market. Many believe the DJIA is too small to represent the market with nearly 4,000 companies publicly traded in the U.S. Others criticize the fact that price-weighted indices don’t take into account percentage changes in share prices. This is something many investors find important. The DJIA does not include stock splits and stock dividends.

The DJIA, despite being criticized for its inaccuracy, is an important stock market index many consider the best.

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