Course 104: Understanding Market Indexes
Calculating the Dow
In this course
1 The Dow
2 Calculating the Dow
3 The S&P 500
4 The S&P 500, Part 2
5 Other Indexes

The index is calculated by taking the 30 stocks in the average, adding up their prices, and dividing by a divisor. This divisor was originally equal to the number of stocks in the average (to give the average price of a stock), but this divisor has shrunk steadily over the years. It dropped below one in 1986 and was equal to 0.144 as of November 2002. This shrinkage is needed to offset arbitrary events such as stock splits and changes in the roster of companies.

With the divisor at 0.144, the effect is to multiply the sum of the prices by about seven. To look at it another way, each dollar of price change in any of the 30 Dow stocks represents a roughly seven-point change in the Dow.

Because the Dow includes only 30 companies, one company can have much more influence on it than on more broad-based indexes. It's also useful to remember that the 30 stocks that make up the Dow are picked by the editors of The Wall Street Journal, rather than by any quantitative criteria. The editors try to pick stocks that represent the market, but there's an inevitable element of subjectivity (and luck) in such a method.

Despite its narrower focus, the Dow tracks quite well with broader indexes such as the S&P 500 over the long run.

Next: The S&P 500 >>

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