In the stock market, the value of any single stock can go up or down on any given day, regardless of the market's overall performance. When trying to assess the broader performance of the stock market, people usually look at stock indexes. A stock index is a measure of the overall performance of a stock market, based on a group of stocks that are meant to represent the market as a whole. The Dow Jones Industrial Average, or Dow, is one of the most common stock indexes used to gauge the performance of the U.S. stock market.
Purpose of the Dow
The Dow is a stock index that is based on 30 of the largest publicly owned corporations in the United States. It includes many well-known companies from different industries, such as Exxon Mobile, AT&T, Microsoft, Wal-Mart and McDonald's. The Dow is supposed to provide a measure the health of the broader U.S. stock market: When the largest companies in the economy perform well, the economy and the stock market as a whole also tend to do well.
Calculating the Dow
The Dow is calculated by adding up the share prices of all 30 stocks that it follows and then dividing by a value known as the Dow divisor. Essentially, the Dow measures the average share price of the 30 stocks that it tracks. The divisor adjusts the average to account for things like stock splits and the adding and swapping of companies from the index over time.
Problems With the Dow
The Dow has some major limitations when it comes to providing a meaningful measure of the performance of the stock market as a whole. Since the index is only based on share prices, stocks with high share prices can have a bigger influence on the Dow than those with low prices. In addition, since the index only includes 30 stocks, it may not always provide a good indication of the direction of the overall stock market.
Despite its shortcomings, the Dow is still one of the most widely used measures of the health of the stock market and the economy. For the average person, the Dow is often synonymous with the stock market itself. On the other hand, other stock indexes that include more stocks, like the S&P 500 and the Wilshire 5000, may provide a more accurate measure of the market's true performance.
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