The Dow Jones Industrial Average, or DIJA, is defined as an average of the share prices of 30 major companies sold on U.S. stock exchanges in order to act as an indicator of how the stock market as a whole is doing.
When the Dow Jones was first launched, it was calculated by taking the price of one share of each of the stocks in the Dow Jones, adding all the prices together, and dividing by the number of companies in the Dow Jones.
However, although that is still the basic premise of the Dow Jones, there is now a more complicated formula used to determine the average. This formula adjusts for companies that are added or removed, or for things such as stock splits. A stock split occurs when a company doubles the number of their stocks and then splits the price of each stock in half.
The formula used for the Dow Jones is also meant to keep the index consistent over time. For example, the index today should be able to be compared to the index thirty years from now or the index from ten years ago. One way that the Dow Jones is able to keep the index relevant and consistent is by changing the divisor.
The divisor is the number that is divided into the total number of stock prices (the number that was twelve when the index first started). As of March 2011, the divisor is 0.132129493.
One of the biggest difficulties of calculating the index is that certain aspects of the index make up larger parts than other companies in the index. The Dow Jones adjusts for this by using a price weighted average. This price weighted average means that expensive stocks have more influences over the index number than less expensive stock prices.
Since the index is based on the dollar number value of the stocks (along with the formula, and the divisor), if a higher stock increases by ten percent and a lower stock increases by ten percent, there would be a greater dollar increase for the higher stock.
The same is true if the higher stocks fall in price verses when the lower stocks fall in price. Thus, the price weighted average ensures that one stock won’t pull the index up too high or one stock won’t pull the index down too far. The Dow Jones is supposed to be a representation of all the thirty companies in the index, and thus one company should not have significantly more weight than another company in the index.(noun)
A stock market index tracking the prices of a share of stock for 30 major companies is an example of the Dow Jones Industrial Average.
See Dow Jones industrial average in Webster's New World College Dictionary
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