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What is the Dow and Why is it Important?

The words Dow or Dow Jones may not be completely unfamiliar terms. You may know what they refer to, but you may not know exactly how it works. So, this article will help set the record straight and give you the basics about the Dow Jones Industrial Average.

What is the Dow Jones? For starters, it would be correct to say that it is the most quoted financial instrument in the world. That is why it sounds familiar. No doubt, you have heard financial market reports about this on the news every day.

The Dow Jones Industrial Average is a stock index. It was created in 1896 by two financial reporters, Charles Dow and Edward Jones. They were looking for a way to give the public a snapshot of how stocks generally preformed in any given day. To do so, they took the 12 largest companies at the time, added up their prices and divided by 12. That gave the average market price of that basket of companies.

Today, the Dow consists of 30 companies. The Dow Jones today represents the most significant areas of the U.S. economy, namely, financials, technology, utilities, industrials, and transportation. It includes companies like Apple, Caterpillar, Coca-Cola, Exxon Mobil, General Electric, Goldman Sachs, Home Depot, Microsoft, Nike, Proctor and Gamble and Walmart.

Because the Dow consists of only 30 companies, it may lead you into thinking that it does not carry much value. That is not the case. As you noticed, these companies are the heavyweights – the most influential companies in the U.S. As the Dow average goes, so usually goes the rest of the market.

Are there Limitations to the Dow Jones?

Just like most market indexes, Dow Jones has several limitations.

The first issue is that it does contain only 30 stocks. Today there are over 3,000 publicly traded companies which you could invest in. So the Dow may not give an accurate portrayal of what is going on in the rest of the stock market.

Secondly, the Dow’s calculation does tend to favor the more expensive stocks. The index is weighted based on price. So the more expensive a stock is, the more an up or down movement in that stock influences the overall index. The less expensive stocks will not have as much influence on the average.

What are the Benefits of the Dow?

1. The Dow serves as a historical marker

In order to predict or forecast the future of the markets, historical trends need to be observed. Analysts study the past stock market trends to help them reach conclusions about what the future may hold for stocks. This is where Dow Jones comes in.

By virtue of its long history, it offers a valuable information for the comparison of today’s markets and those throughout history.

2. The Dow helps investors make decisions

In the early days of stock trading, there was little information about stocks that was available to the general public. You invested in stocks with the phrase caveat emptor (“let the buyer beware”) in the back of your mind. You were at great risk due to lack of company transparency and information.

This is not so today. There are new rules set forth by the Securities and Exchange Commission (SEC) that guard investors from being defrauded by companies. Additionally, news about the Dow and the rest of the markets is widely available through media outlets. It is not difficult for an investor to find the information they need. Knowing the price movement of stocks (for which the Dow is the standard), will help investors know when to invest.

Related Content: The Ultimate Beginners Guide to Investing Money the Right Way

3. The Dow provides a broad view of the economy

As aforementioned, Dow Jones is an umbrella of U.S. most capitalized and influential companies. Because the 30 Dow stocks are spread over different industries, they help create a comprehensive view of the U.S. economy. As those companies perform well, they will contribute positively to economic growth within the U.S. And as the economy goes, so goes the stock market.

If the economy is doing well, the stocks in the Dow will rise. If the economy is doing poorly, the Dow will at best be stagnant but most likely decline.

The Dow Jones continues to be one of the most resilient indices in the world. It has stood the test of time and continues to be the standard for financial markets around the world.

Make a Comment: Do you monitor the Dow on a daily basis? On what do you base your investing decisions?   

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