But what’s a stock market index, I hear you ask. 🤔
A stock market index tracks a group of stocks, and presents an overall value. The higher the value, the more the index is worth. Typically, indices are used to represent the performance of a particular market over a period of time.
Market indexes differ based on two main factors:
The amount of companies the index tracks
The region/ sector the index tracks
In the case of the Dow Jones, it measures the stock performance of 30 large, publicly-traded companies listed on the New York Stock Exchange (NYSE) and the NASDAQ, or in other words, companies listed on major American stock exchanges. It's one of the oldest and most widely-followed stock market indices in the world, dating back to 1896. Told you, old!
Market indexes like the Dow Jones, S&P 500 and FTSE 100 are often used as a benchmark for the overall performance of the stock market. It allows news outlets to summarise what's been happening in the market, which is why they quickly refer to these types of indices.
How is the Dow Jones calculated?
The Dow is calculated by adding the stock prices of the 30 companies it tracks, and then dividing the total by a divisor - a divisor being a number that is used to normalise the Dow's value.
The divisor is adjusted based on market factors that could affect the index's value - stock splits and dividend payments are two prime examples.
So, 30 stock prices added together / divisor = the Dow's value. Simple!
Who created the Dow Jones?
The Dow was created by Charles Dow, Edward Jones and Charles Bergstresser in 1896. During this time, it consisted of just 12 companies and just focused on the industrial sector of the economy. By 1928, it had expanded, including companies from the finance, healthcare, technology and consumer goods sectors - and this resembles what we know today.
Advantages of the Dow Jones
✅ Easy to understand - the Dow is a simple and easy-to-understand index, which acts as a useful tool for both professional investors and individuals wishing to track the stock market.
✅ Historical data - dating back to 1896, it offers a rich amount of previous data which we can study. As well as providing a fairly accurate snapshot of market performance, it's useful for analysts who want to study long-term trends in the stock market.
Disadvantages of the Dow Jones
❌ It's a price-weighted index - companies with the highest stock prices have a greater impact on the overall value of the index. This can lead to a bias towards large, highly valued companies and may not accurately reflect the performance of smaller or mid-sized companies.
❌ It only tracks 30 companies - this is a relatively small number compared to other stock market indexes. The Dow may not be as representative of the overall market as other indexes, like the S&P 500, which if you hadn't guessed, tracks 500 companies!
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