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Number 33

A little on the DJIA

Overview

The Dow Jones Industrial Average (DJIA) has been considered one of the most important indicators of the overall condition of the stock market since it's creation in the late 19th century. The DJIA is a price-weighted average of 30 companies. These companies are perceived to be the largest and most influential companies (blue chip stocks and primarily industrial) on the US markets. The 30 companies are chosen by the editors of the Wall Street Journal (published by Dow Jones & Company), which has been publishing the Dow Jones Averages since October 7, 1896. The DJIA is calculated by adding the prices of the 30 stocks and dividing by an adjusted denominator.

History of the Dow Jones Averages

Charles H. Dow (1851-1902), an American economist and publisher along with Edward D. Jones (1856-1920) established Dow Jones & Co. (1882), a publisher of financial news. In 1889 he founded the Wall Street Journal. Dow wanting a system to keep track of the conditions of the stock market devised a formula to calculate the stock averages starting with only eleven stocks. On May 26, 1896, the first Dow/Jones Industrial Average was published.

Problems in the investment market

In the early years of the investment market (1800's), the general market was bond based. Investors were focused on securities that were backed by physical assets (like factories, machinery, etc.) which had specified interest rates and dates of maturity when the principle was to be returned. The stock market, on the other hand, does not work with the principle of a backed security but rather, works as a partial ownership of an organisation. This partial ownership does not have any claim to that organisations hard assets.

In addition, Wall Street had the problem of analyzing the daily price changes to determine whether stocks generally were rising or not. Charles Dow stepped in with his first Dow Average. In 1884, he began with 11 stocks representing the largest and most influential companies of the time. At the time, railroads were the prime candidate for his averages. Generally, industrial companies were considered more speculative.

The first average

The first average was published on July 3rd, 1884 in Customer's Afternoon Letter. The average initially comprised of:

The first industrial average

Charles Dow continued to modify the list until finally on May 26, 1896 he had created a list that comprised primarily industrial companies. The DJIA had emerged:

In October of 1896, Charles Dow also created the railroad average which consisted of 20 railroad companies and in 1929 he created the utilities averages. The railroad average was later renamed in 1970 to the transportation average. Some of the original companies like GE are still listed on that average today.

For a complete history of the Dow Jones Industrial Average back to 1885 click here.

The DJIA in today's terms

One of the strengths in the DJIA average is that it is a price weighted average. Most other indexes weight their listings and modify their importance based on market capitalization. The DJIA chooses the top 30 companies which represent the majority of the market. Even though there exists some criticism of the choices, the DJIA represents every important sector (with the exceptions of transportation and utilities).

The concept behind using big bluechips behind the index was Charles Dow's reasoning that only the largest and most respectable companies should be part of the average. In the early 20th century these companies were exclusively listed on the NYSE and became known as "blue chips". Today some of the DJIA listings appear on the NASDAQ, and it is not a necessity for the company to be listed on the NYSE.

Companies that are listed on the DJIA are not likely to disappear anytime soon. They are a blend of the largest in the US. These companies are favored by low risk investors because historically, these stocks have stability and pay dividends. However, the price growth is limited. In any case, the Dow averages are indicative of the overall US market trend and are a useful tool to the investor. If an investor would like to invest into the index itself, there is the exchange-traded-fund called the Diamonds found on the AMEX with the ticker symbol DIA.

Historical excel spreadsheet, yearly DJIA values since 1900. (Excel file, .xls)

Calculating the DJIA

To calculate the DJIA, take the sum of all the component prices and divide by the current divisor. Over the years, due to splits and other corporate actions, the divisor is no longer '1'. The current divisor of the Dow Jones Industrial Average can be found here.

Watching the 30 companies that comprise the DJIA

Watching the top 30 companies in the DJIA will give the investor a good appraisal of current market conditions, but how does an investor keep track of 30 stocks on a daily/weekly basis? The answer is building a watchlist of all 30 companies. By doing this, the investor can quickly scan what portions of the index are moving in what direction, since the DJIA is a weighted average, some stocks will have a larger impact on the DJIA than others.

A breakdown of what all the columns represent:

 

Here is the current daily DJIA: (updated daily)

Building your own watchlist

For some traders, the DJIA may not be applicable, but it's always a good idea to have some type of watchlist system setup to track your investments, indexes or just stocks you may be interested in.

Watch this video to create your own watchlist