Even if you aren't a seasoned trader on the stock market, you've probably heard of the Dow Jones Industrial Average(DOW) - Get Report . But even if you're stock savvy, you might not actually know what "the Dow" represents or does.
Since its creation, the Dow has remained one of the most popular indexes to follow on the stock market, and its companies are traded on the New York Stock Exchange (NYSE) and the Nasdaq.
Most recently, the Dow experienced what most experts claim was the longest bull market in history - with the index rocketing up from around 6,500 in 2009 to an astonishing 26,000 in 2018.
Still, how does the Dow work, and what companies does it include ?
What Is the Dow Jones Industrial Average?
The Dow Jones Industrial Average is a price-weighted average of 30 large American publicly traded companies on the stock market. "The Dow," as it is often called, is comprised of big stocks like Apple and Disney, and its stocks are traded on the NYSE and the Nasdaq. The Dow was created by Charles Dow in 1896 as an estimator of the overall market.
The index is meant to be a good indicator of how the overall market and economy are performing in the U.S. by following some of the largest publicly-traded companies.
How Is the Dow Jones Industrial Average Calculated?
So, the Dow is a price-weighted average of the top 30 American stocks. But, what does that mean, and how is it calculated?
Because the Dow is price-weighted, stocks with a higher share price are weighted more than other stocks in the index. Initially, Charles Dow simply added the prices of the 12 stocks he included in his index and divided them by 12. But since the Dow has changed over the years, with different stocks being added or taken off, the average has fluctuated. Additionally, with mergers, stock splits and other corporate activities that have occurred over the years, the value of the index is sure to fluctuate. So, in order to ensure that the index's value isn't affected by a disruption, all 30 stocks in the Dow are instead divided by what is called the "Dow divisor" - which changes over time. The stocks with a higher value are given more weight to ensure that fluctuations don't disproportionately affect the overall index.
In other words, the divisor is used to smooth out fluctuations in the Dow when stock-splits or changes in stock volume occur, and weighs higher-priced stocks more than lower-priced ones.
Because of the price-weighted nature of the index, the Dow is able to withstand individual stocks' fluctuations and remain at a somewhat consistent level among all 30 stocks. But, because it is weighted, the value of the Dow is higher than the actual sum of the individual stocks.
But, how was the Dow actually founded?
History of the Dow Jones Industrial Average
The Dow Jones Industrial Average was founded in 1896 by Charles Dow - the founder of The Wall Street Journal and one of the founders of Dow Jones & Co - with the help of his business partner Edward Jones. Initially, the index was born out of Charles Dow's list of 12 stocks that he tracked daily, which began publishing in 1885 and included two industrial stocks and 10 railroad stocks.
The Dow was (and is) supposed to serve as a sort of general indication of how the greater U.S. market and economy is doing.
For this reason, the Dow is often synonymous with "the market" - for example, when the market is said to be "up" or "down" for a given day, it is usually based off of the Dow and its fluctuations.
Original 12 Companies
When the Dow was first created, the index followed primarily commodity-based stocks. It initially included the following 12 stocks:
- American Cotton Oil
- American Sugar
- American Tobacco
- Chicago Gas
- Distilling & Cattle Feeding
- General Electric (GE) - Get Report
- Laclede Gas
- National Lead
- North American
- Tennessee Coal & Iron
- U.S. Leather Pfd.
- U.S. Rubber
These companies were considered some of the largest and best companies at the time. Still, nearly all have since been replaced over the years.
Changes Over Time
Since its inception in 1896, the Dow has seen quite a few changes.
By 1916, the Dow increased from its original 12 to include 20 stocks - and by 1928, grew again to its current 30. Still, the companies represented in the Dow have changed many times since the 1890s. After the Great Depression, several changes occurred in the index, including the addition of Coca-Cola, IBM and Procter & Gamble in 1932 (all of which are still in the index today).
Additionally, over the course of 1997 to 1999, eight components of the Dow were replaced, with the most recent change being the addition of Walgreens Boots Alliance, Inc. (WGA) to the index in June 2018 - replacing long-time staple General Electric Company.
Which companies make it into the Dow are determined by a committee of representatives as well as representatives from the Wall Street Journal.
In the wake of the 2008 financial crisis, the Dow experienced many changes due to several major companies failing.
Dow Jones Companies 2018
As of Oct. 5, 2018, here are the 30 companies included in the Dow Jones Industrial Average:
Johnson & Johnson
Procter & Gamble
Travelers Companies Inc
Criticism of the Dow
For years, the question of whether the Dow is actually "industrial" or an "average" has been debated. Given that the vast majority of the index's companies are no longer industrial (many are actually tech or financial stocks), and the fact that, essentially, the Dow isn't actually an "average," the Dow's legitimacy has been somewhat speculative.
Some have critiqued the manner in which the Dow calculates its average (through a price-weighted average) compared to other indexes like the S&P 500 (^GSPC) , the latter of which weighs the value of each company based on their size. It is because of this price-weighted average method that the Dow uses that the index has incurred a good bit of criticism, especially when things like stock splits or other disruptions often don't have much of an effect.
And, because the index only includes 30 stocks, some have argued it may not be as good of an indicator of the overall market (which includes thousands of stocks in the NYSE and Nasdaq alone).
Dow Jones Bull Market 2018
As of Aug. 22, 2018, many experts agreed that the American stock market had sustained the longest bull market in history. The Dow is one of the principle ways the bull market is tracked, and the index's rise from around 6,500 points in 2009 to over 26,000 in 2018 (quadrupling in size) in 3,453 days hit the record.
And despite the roller coaster ride that the market has been on in recent weeks, some market bulls claim industrials may help keep the market going.
"If you believe we're in the middle of the cycle and that there is still more steam left in the market, then industrials and IT may be the sectors leading the charge," Mike Loewengart, VP of Investment Strategy at E*Trade told TheStreet back in August.
Still, while the Dow has largely been the key index of the recent bull market, it has suffered notable plummets (as well as enjoyed many upturns) in the past.
While the Dow saw one of the largest one-day percentage increases in 1933 (gaining over 15%), it also saw its largest one-day percentage drop on Black Monday in 1987 (dropping over 22%). The Dow also topped 15,000 for the first time in 2013, and hit its record high at over 26,616 in January of 2018.
Still, as of today, the Dow is up 0.72%, sitting at around 25,454 near close.