Every day, we hear about what number the two indices closed at. What do the numbers actually represent? Are they based on share prices, volume, market cap, or something else? What is the mathematical formula for them?
Unlike the NASDAQ Indexes and the S&P 500 Index, whose components are weighted by market cap, the Dow Jones Industrial Average is price-weighted. For example a 2% movement in Goldman Sachs (which now sells for $251/share) would have about the same effect on the DJIA as a 15% movement in Pfizer (which sells for $34).
That’s rather silly, when you think of it, and means the DJIA is actually less diverse than “30 stocks.” Given such defects it seems remarkable the DJIA is so often the go-to market average.
The whole concept of the DJIA, the S&P 500, and the NASDAQ index is stupid. Since the movement is reported in absolute figures, rather than in percentages, it’s difficult at any time to know what value to attach to a particular up or down. I recall back in the 70s when a 10 pt. movement in the Dow was significant, because the average was hanging around 1000, and that was a 1% movement. Now, a 10 pt. movement is insignificant in comparison, as the market hovers around 20,000 and that’s roughly a .05% change.
Proper graphs of the averages are done on a logarithmic y-axis.
If you listen to Marketplace, it’s always reported in both.
I don’t think I’d go as far as DSYoungEsq and say these averages are stupid … it’s a statistical sampling and in that context the numbers have some value … what’s stupid is how widely and in depth the reporting of this number is … every day on every station always … it’s not all that meaningful …
Many years ago, upon the news that unemployment was significantly lower than expected, the DJIA crashed … labor shortages are good for the poor, they get better pay … but it’s bad for the rich, now they have to pay more … so the DJIA is a fairly good indicator of how well the rich are doing … so remember that next time we’re laid-off to boost corporate profits …
The Dow isn’t really much quoted in serious discussion of markets. It’s just assumed by media and retail brokerage industry to be what every day people are more in touch with and too geeky or in the weeds to quote the S&P. But the S&P is basically ‘the US stock market’ for any serious purpose. It’s only 80% or so of the value (compared to 25% or so for the Dow) but it’s generally not viewed as adding much value to quote total market indexes rather than the S&P.
But the fact that it’s at all remarkable when the Dow seriously diverges from the S&P goes to show that the original ‘modern finance’ concept of a stock market driven by uncorrelated individual company factors, which are mainly diversified away by holding just a few dozen stocks, and a single ‘market factor’, has a good deal of truth to it. If that’s the way the world really works, it shouldn’t make much difference if you focus on only 25% of the market’s cap and calculate the index some weird way. And broadly speaking it doesn’t.
Although again at the margins it does matter, and that’s why you won’t by and large see academic papers studying return phenomena using the Dow, volume in S&P index futures is 10 times that in Dow index futures, etc.
Yes, of course it is. But the DJIA isn’t scaled ever to reflect percentages. Thus, knowing that today it went up 2.5% is great. But what did it do over the last 15 years? Or over the last 10 days? How has the 65-day moving average fared on a percentage basis? etc. etc. etc.