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The Dow Jones Industrial Average (DJIA) is the oldest and best-known stock market index. It measures the daily price movements of 30 large American companies. It is widely viewed as a proxy for general market conditions.

Started in 1896, the DJIA is comprised of 30 North American blue-chip stocks, approximately two-thirds of which are represented by companies producing industrial and consumer goods. The rest are chosen from all the major sectors of the economy including information technology, entertainment and financial services.

What Is "The Dow?"

The Dow Jones Industrial Average (DJIA), popularly referred to as “The Dow,” is regarded as the “pulse of the stock market,” as it is one of the most quoted and followed stock market indexes by investors, market professionals and media. The Dow was unveiled on May 26, 1896 by Charles H. Dow as a composition of 12 stocks. Today, the Dow Jones Industrial Average is a composition of 30 North American blue-chip stocks from varied sectors of the economy. Approximately two-thirds of the index comes from companies producing industrial and consumer goods. The rest are chosen from all the major sectors of the economy except transportation and utilities, which are covered by the Dow Jones Transportation Average (DJTA) and Dow Jones Utilities Average (DJUA).

The component stocks of the DJIA are not permanent; new additions and deletions are made from time to time based on certain non-quantitative criteria. Only companies with a substantial growth record and wide investor interest are considered for inclusion. 

Calculating the Dow Jones Industrial Average

Back in 1896, Charles Dow simply added up the prices of the 12 stocks and divided them by 12. In 1923, Arthur “Pop” Harris was assigned the task of calculating these numbers. After his retirement in 1963, computers were used to calculate the figures.

The DJIA is a price-weighted index, which means the sum of the component stock prices is divided by a divisor. Instead of dividing by the number of stocks in the average, as is done in an arithmetic average, the Dow divisor is used for this index. The purpose of this divisor, which is continually adjusted, is to smooth out the effects of stock splits and dividends and keep the Dow from getting distorted. The result is the DJIA is affected only by changes in the stock prices, so stocks with a higher share price have a larger impact on the Dow's movements. 

 

What the DJIA Measures

The DJIA is simply a reflection of the weighted average of the stock prices and can be considered a price in itself. If the quote moves down by 80 points at the time of closing, it means you can get the stocks for $80.00 less (taking into account the divisor) and they are less valuable than the previous day. Overall, a rise in the Dow signifies a rise in the share prices of constituent companies that reflect a positive outlook and vice versa. Over time the DJIA can be used as a benchmark for the economy.

But remember, a rise in the index may be because of a substantial rise in share prices of a single company that is able to outweigh the fall in share prices of a few of the other stocks. So, even if you are holding shares of a constituent company, a rise in the Dow may not necessarily be indicative of the share price of the company you're invested in moving up. The Dow indicates the average trend of all 30 stocks together; the direction depends on which side is stronger—rise in share prices or fall in share prices.

(For related reading, see: How Now, Dow? What Moves the DJIA?)

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