How The Dow Jones Industrial Average Is Calculated?

Answer 1

The Dow Jones Industrial Average (NYSE: DJI, also called the DJIA, Dow 30, INDP, or informally the Dow Jones or The Dow) is one of several Stock Market indices, created by nineteenth-century Wall Street Journaleditor and Dow Jones & Company co-founder Charles Dow. It is an index that shows how certain stocks have traded. Dow compiled the index to gauge the performance of the industrial sector of the American stock market. It is the second-oldest U.S. market index, after the Dow Jones Transportation Average, which Dow also created. The average is computed from the stock prices of 30 of the largest and most widely held public companies in the United States. The "industrial" portion of the name is largely historical-many of the 30 modern components have little to do with traditional heavy industry. The average is price-weighted. To compensate for the effects of stock splits and other adjustments, it is currently a scaled average, not the actual average of the prices of its component stocks-the sum of the component prices is divided by a divisor, which changes whenever one of the component stocks has a stock split or stock dividend, to generate the value of the index. Since the divisor is currently less than one, the value of the index is higher than the sum of the component prices. To calculate the DJIA, the sum of the prices of all 30 stocks is divided by a divisor, the DJIA divisor. The divisor is adjusted in case of splits, spinoffs or similar structural changes, to ensure that such events do not in themselves alter the numerical value of the DJIA. The initial divisor was the number of component companies, so that the DJIA was at first a simple arithmetic average; the present divisor, after many adjustments, is less than one (meaning the index is actually larger than the sum of the prices of the components). That is: : where p are the prices of the component stocks and d is the Dow Divisor. Events like stock splits or changes in the list of the companies composing the index alter the sum of the component prices. In these cases, in order to avoid discontinuity in the index, the Dow divisor is updated so that the quotations right before and after the event coincide: :

The current value of the DJIA Divisor is 0.1255527090. This value is regularly published in the Wall Street Journal and is available on-line at the Chicago Board of Trade's web site.

Answer 2

Since its creation in the late 1890s, the Dow Jones Industrial Average is one of the most storied, well-known and widely quoted measures of stock market performance there is. Despite its long history, how exactly the index's value is calculated remains a mystery to most even those who have been in the industry for years. Believe it or not, it's not as complicated as it sounds.

The Dow Jones Industrial Average is a price-weighted index. That means that the price of a stock depends on how heavily it's weighted in the index. A stock priced at $100 carries twice the weight of a stock priced at $50. This differs from market cap-weighted indices like the S&P 500 where the largest companies like General Electric and Microsoft are given the greatest weight. In the Dow, a stock like Boeing priced at around $65 is weighted over twice as heavily as Microsoft (priced around $30) despite Microsoft being over five times larger than Boeing.

The Dow contains a total of 30 stocks and the original index value was calculated by simply adding up the prices of each of the components and dividing that number by the number of stocks. Over time, the Dow Jones company realized that events like stock splits as well as adding and removing stocks from the index could potentially skew the continuity of the index's average.

Thus, a divisor was created. This value gets adjusted whenever a stock's value is split (so that the Dow doesn't unfairly drop in value due to an accounting event) or when a stock is swapped out in the index (so that the original index value remains in tact taking into account a new stock price). Today, the sum of the individual component prices is then divided by the divisor number in order to arrive at the final Dow Jones Industrial Average value.