Every night on the evening news, you see numbers relating to the Dow Jones Industrial Average (DJIA) and the S&P 500. The broadcasters seem completely confident talking about these numbers, but do they really know what the numbers mean? What’s more, do you really know what they mean?
The DJIA is an index of stock market prices in the US. It is the most widely used and recognized index for measuring current economic conditions. Likewise, the S&P (Standard & Poor’s) 500 and the NASDAQ composite active stock indexes.
Here are the three most important points you need to know about the Dow:
- Just 30 Companies — Despite what many people believe, the DJIA does not account for every industrial stock on the New York Stock Exchange (NYSE) and the NASDAQ. Rather, it accounts for only 30 of the largest such companies listed. Therefore, while it is a good indicator of the economy, it does not tell the whole story.
- Company Rotation — The companies indexed by the DJIA are not static. The editors of the Wall Street Journal choose them as often as necessary to reflect an accurate picture of the changing economy. Among all of the originals chosen way back when, only General Electric remains.
- Complex Calculations — When the Dow was first invented more than 100 years ago, splits and dividends were not common. You could add up the share prices of all indexed companies and divide by 30 to get the average. Today, the calculation is a lot more complex. It requires considering a number of additional components, including the Dow divisor and price weighing.
Despite its complexity in the modern era, the DJIA continues to be one of the most trusted economic indicators in America. As the Dow goes, so does the NASDAQ, the S&P 500, and most of the other indexes around the world. Suffice to say that when the Dow is doing well, so is the economy in general.