What is 'Theoretical Dow Jones Index'

A theoretical Dow Jones index uses averages of the high and low price for each equity in the index in its daily calculations. The methodology implies all stocks hit their high and low points simultaneously, a rare occurrence in reality.

BREAKING DOWN 'Theoretical Dow Jones Index'

The theoretical Dow Jones index allowed for a rough calculation of the daily highs and lows of the Dow Jones Industrial Average prior to 1992, when the index began publishing prices at 10-second intervals throughout the day. Prior to that point, the index published daily based upon the closing prices of the stocks included in its composition. The theoretical Dow Jones provides a proxy for the amount of market movement that took place for the index via additional calculations made on the high and low prices of each stock. These daily snapshots imply that all stocks hit their high and low points simultaneously, however. A snapshot of the index at its actual low point and high point of the day would likely fall short of the theoretical marks in reality, with theoretical highs higher than the actual high points and theoretical lows lower than the actual low points over the course of a trading day.

History of the Dow Jones Industrial Average calculation

Charles Dow and Edward Jones founded the Dow Jones Industrial Average in 1896, including 12 companies they felt broadly exemplified the strength or weakness of the nation’s stock market. The index weights the price of each stock by its proportion to the overall index, which changes the calculation of the index subtly for any fixed point in time. In other words, a stock with a higher share price gets greater weight in the overall calculation of the index. The index also changes over time as stocks get included in or excluded from the index, and as other events such as mergers or stock splits affect the number and price of shares covered by the index. These adjustments allow for a smoother comparison of the price of the index over time, even as it obscures the relationship between the actual price of the equities in the index and the value of the index itself.

The weighting scheme requires a snapshot of the prices of the underlying stocks, however. Tracking daily movements and other metrics such as highs and lows for the index accurately requires a set of snapshots throughout the day. Before 1992, those snapshots were not readily available. However, the published daily metrics for each stock in the index, including open, close, high and low, provided a relatively easily calculated, rough idea of the movement of the index on a given day.

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