The Dow Jones Industrial Average (DJIA) is inescapable. No matter how middling a news outlet's coverage of business may be, it is a safe bet that the performance of the DJIA or "the Dow" will be offered up as a comment on how the market is doing.

In Pictures: Baby Buffett Portfolio: His 6 Best Long-Term Picks

What is often lacking, though, is a sense of context and significance. Without a bit of perspective on just what the Dow is, it's not that useful to talk about moves in the index, particularly when those moves are talked about only as points.

The Dow
Unlike the S&P 500, the Dow is a price-weighted index. This means that the stocks in that index includes stocks based upon the proportion of the stock prices, so a stock trading at $100 carries 10 times the weight of a stock trading at $10. This is notably different than the market-weighted index methodology (like the S&P 500) where the individual stock prices are irrelevant outside of their impact on the individual companies' market values. This is important to remember because strong performance from those stocks carrying a big nominal dollar price can swing the index more than the stocks that carry lower prices. (Read How Now, Dow? What Moves The DJIA? to find out how this index tracks market movements - and where it falls short.)

A Little Perspective
One of the odd things about the reporting of the Dow's performance is how often reporters and commentators refer only to the number of points the index has moved up or down. There is a psychological reality at work here; if a casual observer hears that "the Dow dropped 400 points", there may be a few moments of heart palpitations and the observer may stay tuned. On the flip side, if the talking head says "the Dow dropped 3.6% today," many more potential viewers may just tune it out, because "3.6%" does not sound like anything so impressive. After all, who comes home and brags that they negotiated a 3.6% raise from their employer?

Clearly this sense of scale is important. An owner of Sirius (Nasdaq:SIRI) is going to feel much differently about a one-point move in that stock than an owner of IBM (NYSE:IBM). Likewise with stocks like Apple (Nasdaq:AAPL) or Google (Nasdaq:GOOG). News presenters love to talk about 10-point moves in these stocks, but just happen to leave out the broader context that, on a percentage basis, the moves just are not that large or significant. (Learn more about the importance of the Dow in Why The Dow Matters.)

What the Dow Has Done
It is all but impossible to make sense of where the Dow is going if you lose sight of where the Dow has been. Much is made of the strong rebound we have seen since the depths of the credit crisis, and it is true that the move from an intraday low of 6469.95 on March 6, 2009 to the close on Monday April 27, 2010 at 11,205.03 has been impressive.

But even more impressive was the drop from the intraday high of 14,198.10 on October 11, 2007 to that low. That was a 54% drop, and while we have seen a 73% rebound, we still need another 27% move to get back where we started. In a normal year, 27% would be an exceptionally strong year, and it is probably reasonable to expect that it will take at least two years to make that move. So when people talk about the impressive rebound in the Dow, just keep in mind that there is still quite a ways to go before we are back where we started.

The Specter of Inflation
There is one other factor that should be considered when talking about long-term moves and long-term records with any stock index, and that is the impact of inflation. Inflation is ever-present and more significant than many investors realize. Consider the following: a stock index could rise by 3% like clockwork every year and the chart will look gorgeous and investors in that index will feel quite proud of themselves. But if inflation has been moving along at 4% every year, the true shape of that index's performance is quite different; every year an investor has held that index, they have lost 1% of actual value.

Why does this matter? Well, if you go back to 2007 and look at the Dow in the context of inflation, the Dow never reached that lofty high of nearly 14,200. In fact, the inflation-adjusted high back in 2007 was slightly below the record set in 2000. (Learn more about inflation in our Inflation Tutorial.)

The Bottom Line
That does not cancel out the nice rebound we have seen, nor does it eliminate the amazing run that the Dow had in the 1980s and 1990s. What it does mean, though, is that you cannot talk about the Dow in a meaningful way if you do not keep the index in its proper perspective.

Still feeling uninformed? Read this week's financial news highlights in Water Cooler Finance: Buffett's Armed and Greece Keeps Falling.

Related Articles
  1. Investing News

    What Shook the U.S. Stock Market Today?

    What was looking as a decent year for US Stock market has suddenly gone off track as the Dow Jones Industrial Average plunged 531 points in the week ending August 23, 2015.
  2. Investing Basics

    Learn About the New York Stock Exchange

    The New York Stock Exchange (NYSE) is nicknamed the “Big Board,” and for good reason. It’s the largest, oldest and best-known stock exchange in the world.
  3. Fundamental Analysis

    Calculating Free-Float Methodology

    Free-float methodology is used to calculate the total market capitalization of an index’s underlying companies.
  4. Investing

    What Rising Volatility Means for Momentum

    After remaining torpid for most of the year, equity market volatility is once again rising.
  5. Term

    Risk and Reward In Emerging Market Economies

    An emerging market economy is one that’s progressing into an advanced economy.
  6. Investing

    What Are The Three Key Elements of a Bond ETF?

    We explore the bond ETFs basics, because the only way to appreciate the benefits that this type of investment offers is to first understand how they work.
  7. Fundamental Analysis

    Explaining the Capital Market Line

    The capital market line (CML) depicts the level of additional return above the risk-free rate for each change in the level of risk.
  8. Term

    How Equity Capital Markets Work

    An equity capital market is a market existing between companies and financial institutions that raises money for the companies.
  9. Trading Strategies

    Microsoft's Game of Catch-Up With The Dow

    Microsoft (MSFT) underperformed the Dow Jones Industrial Average during the 2002 to 2007 bull market, but it has played catch-up in recent years.
  10. Economics

    Do Transport Stocks Signal a U.S. Selloff?

    The Dow Jones Transportation Average index has underperformed the broader DJ Industrials Average, leading some market watchers to speculate a selloff.
RELATED TERMS
  1. Market Value

    The price an asset would fetch in the marketplace. Market value ...
  2. Bulldog Market

    A nickname for the foreign bond market of the United Kingdom. ...
  3. Float Shrink

    A reduction in the number of a publicly traded company’s shares ...
  4. Capital Strike

    A refusal of businesses to invest in a particular sector of the ...
  5. Gray Market

    An unofficial market where securities are traded. Gray (or “grey”) ...
  6. Floating Stock

    The number of shares available for trading of a particular stock.
RELATED FAQS
  1. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  2. What is the difference between shares outstanding and floating stock?

    Shares outstanding and floating stock are different measures of the shares of a particular stock. Shares outstanding is the ... Read Full Answer >>
  3. What is the difference between market risk premium and equity risk premium?

    The only meaningful difference between market-risk premium and equity-risk premium is scope. Both terms refer to the same ... Read Full Answer >>
  4. What is the difference between the QQQ ETF and other indexes?

    QQQ, previously QQQQ, is unlike indexes because it is an exchange-traded fund (ETF) that tracks the Nasdaq 100 Index. The ... Read Full Answer >>
  5. What is the difference between an investment and a retail bank?

    The activities and types of clients for an investment bank versus those for a retail bank highlight the primary difference ... Read Full Answer >>
  6. Will technology ever disrupt the role of the custodian bank?

    Custodian banks, along with other financial institutions that hold custodian accounts, are likely to be disrupted but not ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!