The Dow Jones represents the 30 top traded and highly influential companies in the American economy. It is also an indicator of general market trends, based on which traders can place successful exit or entry orders.
In our article, we will learn in-depth about Dow Jones and how it works.
What is Dow Jones?
The Dow Jones Industrial Average is the stock average that measures the market’s trend direction. It consists of the 30 most traded stock prices, and the price of Dow Jones reflects the market’s performance. Whenever the Dow increases, it indicates a bullish market and signals traders to long the trade. Whenever the Dow decreases, it indicates a bearish market and signals traders to short the trades.
How does Dow Jones work?
The Dow Jones works by calculating the 30 current prices of the most influential company’s stocks in the US market. All the prices are added and divided by the Dow divisor, which changes regularly. The Dow divisor is a value used to calculate the Dow Jones Industrial Average and is shown every day on the Wall Street Journal under the ‘daily change’ column.
Let us take an example of considering an index with ten stocks that sum up to $500, with the divisor in our example being 10. This brings the average price of the Dow index to $500/10 = $50.
Now, one of the stocks that originally cost $100 decreases in value and comes to a total of $50. If we do not change our divisor, the average would be $450/10 = 45. However, this calculation is inaccurate since we need to change the divisor as stock value decreasing does not mean a decrease in the company’s value.
Hence, we need to adjust the Dow divisor as well to 9.5. This brings the index to $450/9.5, almost the same level as before, at $47.36. This reflects the value of all stocks on average more accurately.
What companies are in the Dow Jones Industrial Average?
The Dow Jones Average consists of 30 large-cap US stocks traded publicly. These companies are the most highly reputed ones not only in the US but around the globe and are listed on the Nasdaq or the New York Stock Exchange. Big influential companies like Apple, Microsoft, UnitedHealth, Walmart, JPMorgan Chase, and more are a part of this index.
How does a stock get added to the Dow Jones Industrial Average?
The stocks that are considered in the Dow 30 are chosen by the members of a committee that represents three people as S&P Dow Jones Indices representatives and two people as the Wall Street Journal representatives. These five people together decide what stock needs to be added to the index after evaluating the stock process and other corporate actions after comparing the index to the broader stock market.
When a company is removed from the Dow, it generally results in a big drop in its price and when it is added, it results in a huge increase.
Dow Jones Industrial Average vs. S&P 500: What’s the difference?
Both Dow Jones Industrial Average (DJIA) and Standard & Poor’s 500 Index (S&P 500) are two of the most popular American indexes in the market. Both indexes provide traders with general market sentiment.
The DJIA, established in 1896, provides an average value of the 30 most influential and large US companies that are from various industries except transportation and utilities. All companies in DJIA are big brand names like Microsoft, Coca-Cola, Johnson & Johnson, and more. Whereas S&P 500, created in 1957, represents a bigger set of 500 companies from different industries and sectors like Amazon, 3M, Abbott Laboratories and more.
The companies belonging to DJIA don’t vary much as the addition and removal of companies in DJIA is a stringent and serious process. On the other hand, stocks to be added to the S&P 500 need to have a Dow Jones Industrial Average market cap of at least $14.6 billion, a public float of 10% at the very least, and adequate liquidity and positive earnings.
Lastly, both indexes differ in the way they are weighted. The Dow is weighted on a price-weighted mechanism. Hence, instead of using a simple arithmetic average to decide the total of stock prices with the number of stocks, we use a Dow divisor. The divisor is used to smooth out stock dividends and splits. This results in the index being affected only when a stock price changes. Whereas all stocks in S&P 500 are weighted according to their market value and not prices. Hence, any percentage change in the stock prices affects the index the same way, irrespective of the value of the stock.
Learn more about trading and the DJIA with us
The DJIA consists of all the blue-chip stocks that show excellent performance in the stock market. It is one of the oldest and most widely used indexes, and you can learn more about it on our platform.
You can also trade these stocks via CFDs with Blueberry.
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