The average consists 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.
The DJIA was first published in Customer's Afternoon Letter. It was published on May 26, 1896, and represented the average of twelve stocks from important American industries. Of those original twelve, only General Electric remains part of the index. The other eleven were:
When it was first published, the index stood at 40.94. It was computed as a direct average, by first adding up stock prices of its components and dividing by the number of stocks in the index. The Dow averaged 5.3% compounded annually for the 20th century, a record Warren Buffett called "a wonderful century"—when he calculated that to achieve that return again, the index would need to reach nearly 2,000,000 by 2100. Many of the biggest percentage price moves in The Dow occurred early in its history, as the nascent industrial economy matured. The index hit its all-time low of 28.48 during the summer of 1896.
On July 30, 1914, when the New York Stock Exchange was closed for the next four months, the index stood at 71.42. Some historians believe the Exchange closed because of a concern that markets would plunge as a result of panic over the onset of World War I. An alternative explanation is that the Secretary of the Treasury, William Gibbs McAdoo, closed the exchange because he wanted to conserve the US gold stock in order to launch the Federal Reserve System later that year with enough gold to keep the US on the gold standard. When the markets reopened on December 12, 1914, the index closed at 54, a drop of 24.39%.
In 1916, the number of stocks in the index was increased to twenty and the new version of the index was 27% smaller than the old index. Finally, it was increased to thirty stocks in 1928, near the height of the "roaring 1920s" bull market. The crash of 1929 and the ensuing Great Depression returned the average to its starting point, almost 90% below its peak, by July 8, 1932, at its intra-day low of 40.56; closing at 41.22. The high of 381.17 on September 3, 1929, would not be surpassed until 1954, in inflation-adjusted numbers. However, the bottom of the 1929 DJIA crash came just 2 1/2 months later on November 13, 1929, when intra-day it was 195.35; closing slightly higher at 198.69.
The 1980s and especially the 1990s saw a very rapid increase in the average, though severe corrections did occur along the way.
The uncertainty of the 2000s brought a significant bear market, followed by indecision on whether the following bull market represented just a prolonged cyclical rally or the start of a new secular trend.
The Dow Jones Industrial Average consists of the following 30 companies:
The individual components of the DJIA are occasionally changed as market conditions warrant. When companies are replaced, the scale factor used to calculate the index is also adjusted so that the value of the average is not directly affected by the change.
On November 1, 1999, Chevron, Goodyear Tire and Rubber Company, Sears Roebuck, and Union Carbide were removed from the DJIA and replaced by Intel, Microsoft, Home Depot, and SBC Communications. Intel and Microsoft became the first two companies traded on the NASDAQ exchange to be listed in the DJIA. On April 8, 2004, another change occurred as International Paper, AT&T, and Eastman Kodak were replaced with Pfizer, Verizon, and AIG. On December 1, 2005, AT&T returned to the DJIA as a result of the SBC Communications and AT&T merger. Altria Group and Honeywell were replaced by Chevron and Bank of America on February 19, 2008. On September 22, 2008, Kraft Foods replaced American International Group in the index.
To calculate the DJIA, the sum of the prices of all 30 stocks is divided by a 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:
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:
With the current inclusion of only 30 stocks, critics like Ric Edelman argue that the DJIA is not a very accurate representation of the overall market performance even though it is the most cited and most widely recognized of the stock market indices. Historically, though, it has performed very much in line with the broader U.S. market.
Additionally, the DJIA is criticized for being a price-weighted average, which gives relatively higher-priced stocks more influence over the average than their lower-priced counterparts. For example, a $1 increase in a lower-priced stock can be negated by a $1 decrease in a much higher-priced stock, even though the first stock experienced a larger percentage change. As of September 2008, IBM is the highest priced stock in the index and therefore has the greatest influence on it. Many critics of the DJIA recommend the float-adjusted market-value weighted S&P 500 or the Dow Jones Wilshire 5000, the latter of which includes all U.S. securities with readily available prices, as better indicators of the U.S. market.
Another issue with the Dow is that not all 30 components open at the same time in the morning. On the days when not all the components open at the start, the posted opening price of the Dow is determined by the price of those few components that open first and the previous day's closing price of the remaining components that haven't opened yet; on those days, the posted opening price on the Dow will be close to the previous day's closing price (which can be observed by looking at Dow price history) and will not accurately reflect the true opening prices of all its components. Thus, in terms of candlestick charting theory, the Dow's posted opening price cannot be used in determining the condition of the market.
The Full Monte: You may be exposing your clients to shortfalls in their retirement if you fail to consider the assumptions in your Monte Carlo analyses.(Statistical Data Included)
Jun 01, 2002; You've worked with your client to select an appropriate list of investment vehicles and portfolio mix consistent with his or her...