How is the Dow Jones average calculated?

Answer 1

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.