How does one read the Dow Jones stock exchange?

Answer 1

As you might have guessed, calculating the DJIA today isn't as simple as adding up the stocks and dividing by 30. Dow lived in times when stock splits (To learn more, see What is a stock split? Why do stocks split?) and stock dividends weren't commonplace, so he didn't foresee how these corporate actions would affect the average. For example, if a company trading at $100 implemented a 2-for-1 split, the number of its shares doubles, and the price of each share becomes $50. This change in price brings down the average even though there is no fundamental change in the stock. To absorb the effects of price changes from splits, those calculating the DJIA developed the Dow divisor, a number adjusted to account for events like splits that is used as the divisor in the calculation of the average. How Does the Dow Divisor Work? To calculate the DJIA, the current prices of the 30 stocks that make up the index are added and then divided by the Dow divisor, which is constantly modified. To demonstrate how this use of the divisor works, we will create a mock index, the Investopedia Mock Average (IMA). The IMA is composed of 10 stocks, which total $1,000 when their stock prices are added together. The IMA quoted in the media is therefore 100.00 ($1,000/10). Note that the divisor in our example is 10. Now, let's say that one of the stock in the IMA average trades at $100 but undergoes a 2-for-1 split. Its price then reduces to $50. If our divisor remained unchanged, the calculation for the average would give us 95.00 ($950/10). This would not be accurate because the stock split merely change the price, not the value of the company. To compensate for the effects of the split we have to adjust the divisor downward to 9.5. This way, the index remains at 100.00 ($950/9.5) and more accurately reflects the value of the stock in the average. If you are interested in finding the current Dow divisor, you can find it at the website of the Dow Jones Indexes and the Chicago Board of Trade. And How Does the DJIA Number Translate into a Dollar Value? To figure out how a change in any particular stock affects the amount the index changes, up or down, divide the stock's price change by the current divisor. For example, if General Electric was up $5, divide 5 by 0.14418073, which equals 34.68. Thus, if the DJIA was up 100 points on the day, GE was responsible for 34.68 points of the move. Conclusion The DJIA's methodology of calculating an index is known as the price-weighted method. On top of having to deal with stock splits, the downside to this method is that it does not reflect the fact that a one dollar change for a $10 stock is much more significant (percentage wise) than a one dollar change for a $100 stock. Because of price-weighting's associated problems, most all other major indexes such as the S&P 500 are market-capitalization weighted That being said, despite all the shortcomings, the Dow is still one of the most watched indicators of Stock Market performance. by Investopedia Staff, (Contact Author | Biography)