The Dow: Then & Now

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There's so much talk of the markets crashing, the Dow dropping, then rising, then dropping again. Under 9,000 today, over 9,000 tomorrow. But what do these numbers even mean? What is this "˜Dow' on which investors and the media fixate themselves? And is it really comprised of only 30 stocks?

The Dow is a market index, which is a listing of stocks that share some similar characteristic; they could belong to the same industry or they could all have similar market cap (how much a company is worth).

The Dow, the NASDAQ, and the S&P500 are the three main market indexes, providing the basic signal of how markets perform. The Dow is the most widely publicized and discussed, thus I'll follow suit.

First, some history.

The Dow Jones Industrial Average was started in 1896 by Charles Dow, the editor of the Wall Street Journal's precursor, the Customer's Afternoon Letter. Dow had a vision to create a benchmark that would project the general market conditions. Interesting to note that of the original 12 stocks of the DJIA, General Electric remains a part of the average (though it was taken out and reinstated twice). Today it is made up of 30 of the largest blue chip companies in the US that are traded on the NYSE, as selected by the editors of the Journal. The composition of the Dow changes fairly often. In fact, here's a list of the deletions and additions over the past 30 years.

936 points. So what? Even though it's called the Dow Jones Industrial AVERAGE, they don't simply add up the stock prices of the 30 companies and divide by 30. No, the average is price-weighted, meaning each stock influences the Dow in proportion to its share price. In order to account for stock splits (when a company's existing shares are divided into multiple shares making, for instance, a $100 share worth two $50 shares, which is typically done to make shares seem more affordable when a company's stock gets too high, or higher than that of other companies in the same industry) and stock dividends, they create a Dow divisor by which the sum of the 30 companies' prices is divided. That divisor is constantly changing depending on the stocks in the average, the splits and extra shares issued.

Can I buy the DJIA as if it were a stock? Well, not really. You can't buy the DJIA as if it were a security, but you can buy a Diamonds ETF, which basically gives you a small ownership of the 30 stocks in the Dow. An ETF is an Exchange-Traded Fund that puts a bunch of pieces of stock into one overarching stock. You may be more familiar with the SPDR—Standard & Poor's Depository Receipt, or Spider—which is an ETF for stocks in the S&P500. ETF's hedge your risk - if one stock does poorly, you have others to back you up. 

The Dow: Now and Then

Last week, the Dow almost crashed. Almost, but not quite - because by common definition a market crash is a 20% decline in a single day or several days. Last week, the Dow fell 18.2% or 1,874.19 points, making it the worst week in market history (prior to last week, the largest weekly percentage drop was the week ending July 22, 1933, when it fell 17%).

We saw a brief rebound, when history was made again. Monday, the Dow rose 936 points, the largest single day gain in market history. Then down again. Then back up. Then...

After the market crashed in 1929, it took twenty-five years to return to the pre-crash peak of 381.17 (late 1954). But this is not 1929. We have stronger governmental agencies to help fix the mess (The Fed has more power, and the FDIC provides deposit insurance.) We are coming down from an all-time high (14,164.53 a year ago). We acted fast and have allocated over $1 trillion (of our tax dollars) to fix this up. Despite these differences, however, history may not bode well for us.

October 16, 2008 - 11:21am
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