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Dow Jones How relevant is it to us today?

Updated on April 8, 2008

The Dow Jones Industrial Average – How Relevant?

If you watch the business news, you hear all the time about the Dow Jones Industrial Average (DJIA), the S&P 500, the FTSE 100, and other averages that give an indication of the financial health of a stock market. The Dow, which we will consider here, is somewhat unusual in that it takes the share values of just 30 companies, and calculates a weighted number as its result to represent the entire US financial climate. The S&P 500, in contrast, averages 500 share prices in the US, and the FTSE 100 uses 100 share prices from the London Stock Exchange.

To be sure, the companies that are selected for inclusion as components of the index are some of the most well known and largest in the US, and possibly the world. They include the likes of IBM, General Motors, General Electric, Goodyear, Bank of America, Chevron, etc. The term “industrial” is interpreted liberally, and includes most sectors of business – as you can see, finance, oil, manufacturing and technology are included even in this small sample. The chief reservation in selecting companies is that they are not in the transportation field, for which Dow has a separate index, the Dow Jones Transportation Average (DJTA), and not utility companies – again, a separate index takes care of those.

Despite the small number of companies, the Dow reacts well to changes in the economy, seeming to reflect the mood as accurately as the larger indices, and may be the most famous and most referred to index of them all. There is nothing magic about its operation, but the judicial selection of the component companies, and changes in content when appropriate, are performed with diligence by the editors to maintain the stability and respect. The editors involved with the index are also the editors of The Wall Street Journal, so they have the experience and knowledge to make these choices.

The DJIA was started in 1896 by Charles Dow, who was at that time the editor of The Wall Street Journal. Mr. Dow was a journalist from the age of 21, working first in Massachusetts, and eventually relocating to New York City in 1879. In 1882, he joined with Edward Jones to form Dow Jones & Company, located in Wall Street, and the company provided news to banks and brokerages in the form of a handwritten broadsheet. In 1884, he started running an index in the newsletter, which was then called the Customer’s Afternoon Letter. This index was calculated from eleven share prices, nine of which were in the railroad industry, and it was called the Dow Jones Average.

In 1889, the newsletter became The Wall Street Journal, with Charles Dow still as editor, a position he maintained until 1902, when failing health caused him to resign, and he died later that year at the age of 51. The DJIA was a development from the Dow Jones Average, and started with twelve companies, but excluded transportation and utilities, as Dow included these in other indices. The only one of those twelve companies which is still included in the DJIA is General Electric, but the current choices and weightings appear to be as relevant today as they were when Charles Dow was alive.

Charles Dow has achieved the status of a household name with his index, but he is also known for other work amongst those who follow the markets. His editorials have been combined to produce a stock selection method which is now referred to as the Dow Theory. It appears that it was never referred to as such before his death, and perhaps the writers wished to add some credence to the analytical system by attaching what was certainly a well known name at the time, but it is said to be a result of his thoughts and research, at least in part. You can find further details on the Dow Theory and other trading techniques by going to www.insightsupport.com, where Stu Whisson has some free downloadable courses.

What is known is that Charles Dow became very experienced in analyzing stock movements as a result of his position. He was a follower of the relative movements of the industrial and transportation indices, asserting that if they did not move in concert, then any gains in one were not supported by the other, and would not be long lasting. This arises from the idea that increased production by the industrials would need increased transportation for distribution, and thus discrepancies in the index movements pointed to an indication that should be questioned. He also noted that stock prices move in trends, unless a major upset occurs to stop the trend, and he researched patterns in the trends. He noted that many underlying or primary trends were broken up with secondary trends in the opposite direction, or retracements as they are referred to nowadays.

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