Why the Dow Matters

The Dow Jones Industrial Average (DJIA) is one of the most quoted financial barometers in the world and has become synonymous with the financial markets in general. When people say the market has gone up or down by a certain number of points, there’s a good chance they’re referring to changes in the Dow. 

Key Takeaways

• The Dow Jones Industrial Average (DJIA) was created to serve as a stock market and economic indicator. 
• Charles Dow’s first version of the DJIA appeared in the Wall Street Journal in 1896, containing 12 stocks. 
• The DJIA expanded to 30 stocks in 1928, which is the number of stocks it still maintains today. 
• The DJIA has proved to be a solid representation of the broader market, closely tracking the much more inclusive Wilshire 5000 index.  

Brief History

Charles Dow, the creator of the DJIA, devised his first stock index in 1884. It consisted of two capitalized industrial and 12 capitalized railroad companies. Dow’s intent was to track U.S. economic strength by closely observing the companies considered to be the backbone of the U.S. economy. 

In 1896, Dow altered the index to contain 10 railroads and two industrials. In the mid-1890s, Dow recognized the growing importance of the industrial sector in the U.S. economy and again altered the index, this time to consist solely of industrial stocks. The first version of the DJIA, which contained 12 stocks, appeared in The Wall Street Journal on May 26, 1896. The companies chosen were:

• American Cotton Oil
• American Sugar
• American Tobacco
• Chicago Gas
• Distilling & Cattle Feeding
• General Electric
• Laclede Gas
• National Lead
• North American Utility
• Tennessee Coal and Iron
• U.S. Leather pfd.
• U.S. Rubber

While an odd-looking combination by today’s economic standards, these 12 stocks were carefully chosen to represent the major areas of the U.S. economy at the time. The 30-stock Dow Jones Industrial Average debuted in 1928. It was made up of:

• Allied Chemical
• American Can
• American Smelting
• American Sugar
• American Tobacco
• Atlantic Refining
• Bethlehem Steel
• Chrysler
• General Electric
• General Motors Corporation
• General Railway Signal
• Goodrich
• International Harvester
• International Nickel
• Mack Truck
• Nash Motors
• North American
• Paramount Publix
• Postum Incorporated
• Radio Corporation
• Sears Roebuck & Company
• Standard Oil (N.J.)
• Texas Company
• Texas Gulf Sulphur
• Union Carbide
• U.S. Steel
• Victor Talking Machine
• Westinghouse Electric
• Woolworth
• Wright Aeronautical

The DJIA has changed over the years, with some stocks being removed and others added to maintain an accurate reflection of the U.S. economy. Of the original 12 Dow stocks, General Electric (GE) is the only one that stood the test of time, remaining in the index until 2018.

There are also two other Dow averages, the Dow Jones Utility Average (DJUA) and the Dow Jones Transportation Average (DJTA), which consists of stocks in the railroad, trucking, shipping, and airline industries.

Today’s Dow

The table below alphabetically lists the companies included in the DJIA as of June 2024:

As you can see, today’s Dow consists of many household names that the average American comes across on a daily basis. It’s also evident from the year added column that the companies that make up the index aren’t chopped and changed on a regular basis.

Note

The longest-serving company currently in the DJIA is Proctor & Gamble. The consumer goods giant was first added to the index in 1932.

Is the Dow a Reliable Economic Indicator?

Considering the breadth of today’s economy, one might mistakenly believe that an index consisting of a mere 30 stocks could hardly be of any value. That is simply untrue. In addition to representing 30 of the most highly capitalized and influential companies in the U.S. economy, the Dow is also the financial media’s most referenced U.S. market index and remains a good indicator of general market trends.

If one compares a pricing chart of the Dow with a chart of the Wilshire 5000, the most inclusive of all U.S. indexes, it is evident that the two have followed astonishingly similar paths. The Dow has historically begun to decline for extended periods before the more speculative Nasdaq index, a pattern that occurred in the stock market downturns that began in April of 1998, January 2000, December 2001, January 2004, December 2004, and October 2007. Some believe that when the stocks of DJIA companies begin to show weakness, the U.S. economy may be headed for a slowdown.

Dow Theory

The DJIA can also be used with another Dow Jones index covering transportation to determine the direction of the stock market. 

During his career, Charles Dow came up with a theory that the market is in an upward trend if one of the averages he created, either industrials or transportation, advances above a previous important high and is accompanied or followed by a similar advance in the other one. In other words, if the DJIA climbs to a high and the DJTA follows a similar pattern around the same time, it would confirm a bull market. Likewise, if both indexes were to move notably down in quick succession, it could indicate an incoming bear market.

The Dow Theory makes six basic assumptions:

1. A stock’s price reflects everything that is known about the stock.
2. There are three primary kinds of market trends: a primary trend, which lasts a year or more, a secondary trend, which represents smaller movements, such as a pullback within a bull market or a rally within a bear market, and a minor trend, which lasts a few days or weeks.
3. Primary trends have three phases: In an uptrend, they are the accumulation, public participation, and excess phases. In a downtrend, they are the distribution, public participation, and panic phases.
4. The averages must confirm each other: For a trend to be valid, the industrials and transport indexes must move in a similar direction.
5. The volume confirms the trend: When the price is moving in the direction of the primary trend, the volume should increase. If this doesn’t happen, the trend can be considered weak.
6. Trends persist until a clear reversal occurs: Uptrends are defined by a series of higher highs and higher lows and downtrends by a series of lower peaks and lower troughs. In the case of a bull market ending, prices must exhibit at least one lower high and one lower low.

Ways to Invest in the DJIA

There are a number of ways to invest in the Dow Jones Industrial Average. The most obvious is to buy shares of the companies it includes. But several exchange-traded funds (ETFs) also track the price movements of the Dow, including the SPDR Dow Jones Industrial Average ETF (DIA) and ProShares Ultra Dow30 (DDM).

Is the Dow more important than the S&P 500?

A lot of pundits consider the S&P 500 to be more reflective of the state of the stock market and economy because it includes more companies, weights them according to size, and is revised on a more frequent basis. Still, the Dow tends to be quoted more and has proved over the years to be fairly representative of the U.S. equity market, despite containing just 30 stocks. A lot of that is down to the companies being well-chosen.

Should I invest in Dow, Nasdaq or S&P 500?

That depends on what kind of investor you are. The S&P 500 contains more stocks and is, therefore, in theory, more diversified, whereas the Nasdaq, despite holding some of the country’s biggest companies, is generally considered to be more speculative by nature because of its focus on technology. The Dow, on the other hand, is often criticized for just having 30 stocks. But, in its defense, the companies in this index are very diverse and fairly evenly represented. They are also personally handpicked by a committee for their quality characteristics.

Each of these indexes has something to offer. The Nasdaq is generally associated with growth and volatility, the Dow with stable earnings and decent dividends, and the S&P 500 with a little bit of both.

What is the advantage of Dow Theory?

Dow theory can help traders to identify trends in the market and determine in which direction it is heading. The theory does make a lot of sense. However, like all trading frameworks, it isn’t flawless and won’t always deliver the desired results. When investing, it’s wise not to rely on and blindly follow just one theory. Accompany other people’s observations with different analyses and your own due diligence.

The Bottom Line

The DJIA isn’t loved by everyone. Some argue that this index, which consists of 30 blue chips considered to be the most important names on the New York Stock Exchange (NYSE) and NASDAQ, doesn’t achieve its goal of reflecting the health of the U.S. economy because it consists of just 30 companies and puts more weight on share prices than market capitalization.

There is a reason, though, why the Dow is the financial media’s most referenced U.S. market index. Despite all the criticism, it has actually proven to be a fairly reliable indicator of where the stock market and economy are heading. Over the years, its price movements have closely mirrored the Wilshire 5000, a much broader index covering 5000 U.S.-listed stocks. And when its constituents, who are major employers and are heavily invested in the economy struggle, the wider economy tends to start stuttering, too. These are just some of the reasons why the Dow matters and is frequently talked about.

Read the original article on Investopedia.