The Dow Jones Industrial Average (also known as the DJ30 or just Dow) is a price-weighted stock market index, created by Wall Street Journal Editor, Charles Dow. The industrial average is the oldest stock index in the world and was first calculated on May 26, 1896.
The Dow remains one of the most closely monitored and regularly cited stock indexes as a measure of stock market performance. When we hear news reports claiming the ‘market is up (or down)’ for the day, it is often referring to the movement of the Dow.
The Dow measures the performance of 30 large, publicly-owned companies in the US stemming from a wide array of industry sectors, ranging from health-care to financial services among others. The 30 stocks in the Dow can dictate the movement of the entire stock market as it is such a strong indicator of the US economy and investor sentiment towards equities.
30 Companies in the Dow Jones*
|American Express||Goldman Sachs||Pfizer|
|AT&T||Home Depot||Procter & Gamble|
|Caterpillar||IBM||United Health Group|
|Chevron Corp||Johnson & Johnson||United Technologies Corp|
|Cisco Systems||JP Morgan Chase||Verizon|
|Exxon Mobil||Microsoft||Walt Disney|
*As of 30 September 2013
The price-weighted nature of the Dow means that companies with the highest stock prices will have the biggest weight on the index. As of 30th September, there are seven companies with share prices above $100 a share. They are Boeing, Chevron, Goldman Sachs, IBM , 3M, United Technologies and Visa being the highest at nearly $200 a share.
Additions and Removals to the Dow
Companies have been removed and added to the Dow over the years since its inception. Most recently we have seen the addition of Goldman Sachs, Nike and Visa on the 20th September 2013 replacing Alcoa, Bank of America and Hewlett-Packard. There are several reasons why companies are removed and added to the Dow.
The reasons for this latest switch up were that the Index Committee (who decides on membership) wanted to further diversify the industry sectors in the index and the prices of the three stock that left were deemed to be too low.
Calculation of the Dow
The value of the Dow is not the actual average of the prices of its component stocks, but rather the sum of the prices divided by a unique divisor. This divisor changes whenever one of the component stocks has a stock split or stock dividend, so as to generate a consistent value for the index. Also, the divisor will be adjusted if there is a new company replaces another.
Since the divisor is currently less than one (0.130216081 as of September 2013), the value of the index is larger than the sum of the component prices – around 15,000 (23rd September 2013).
The Dow – Past & Present
The mid-1990s brought about a big surge in the value of the Dow thanks to rapid advances in technology. The dot-com boom saw the Dow exceed 315% percent for the decade and the 90s closed out around the 11,000 level.
The start of the 2000s, however, saw the Dow take a big hit in value as we saw the lingering effects of the dot-com bubble as well as the political and social impacts of the Afghan War, the Iraq War and the 9/11 attacks. At this stage, the Dow was valued between 7,000 and 9,000.
The mid-2000s, however, saw the Dow soar again on the back of the global boom, healthy company earnings and positive inflation rates. It hit a record high on October 9th 2007 of 14,164.53.
However with the collapse of Lehman Brothers and the US and global credit crunch we saw the Dow collapse in value during late 2008 and early 2009, with a 12 year low being recorded on the 9th March 2009 of 6,547.05. The Dow made a notable recovery in late 2009 aided by US monetary policy.
2013 has been a positive year for the Dow where investment in equities has been very positive. The surge in value has also been attributed to monetary policy, in particular, the Federal Reserve’s third attempt at quantitative easing – QE3.
Recent Historical Performance of the Dow
Below we see a one-day line chart of the Dow from mid-2008 to September 2013.
Criticisms of the Dow
While the Dow remains the most regularly cited index in the US there are many critics of its makeup and calculation.
As we have mentioned previously the Dow is a price-weighted index so it allocates more influence to stocks with a higher share price, but it does not take into consideration the relative industry size or market capitalization of each component.
Therefore stocks such as Goldman Sachs and IBM have a much greater influence on the index than other similarly large companies like General Electric and Intel due to their higher stock price.
Additionally, a regularly mentioned criticism of the Dow is the fact it has only 30 components. Some critics believe it is therefore not an accurate representation of overall market performance, especially when there are over 15,000 publicly traded companies in the US.
A combination of these two criticisms is why we see the notable exclusions of the largest publicly traded stocks – Apple and Google. Due to the price of their stock (around $500 and $900 respectively as of 23rd September 2013) they cannot be added as a movement in their stock price would have too large an impact on the index as a whole.
Things to Remember When Trading the Dow
- The DJ30 futures contract is tradable from 22:01 – 20:14 (GMT), Monday to Friday.
- The DJ30 moves in increments of 1.00.
- The margin requirement for trading the DJ30 is usually about 0.5% (i.e. 200 to 1 leverage) with most brokers.
- The minimum trade size is 1 index.
- The currency of the DJ30 is the US Dollar.
So let’s say we want to BUY 1 index of the DJ30 and it is currently priced at 15,100 and we have a US dollar-denominated trading account:
The margin (or funds) we would need to put up to open this position would be $75.50.
($15,100 (price of DJ30) X 0.5% (margin requirement) = $75.50)
This amount can be seen in the ‘used margin’ section on our trading platform.
If we have an account in a different base currency such as Euro, our margin remains 0.5% but our trading platform will automatically convert the $75.50 to Euro.
So say the EUR/USD rate is 1.3500. We then see approximately €55.90 in the ‘used margin’ section on our Euro account.
Every move in the DJ30 is $1.00, so in our example, if we bought 1 index and the DJ30 rises from 15,100 to 15,200 we make a profit of $100 (or €74.07 at our exchange rate above).