Dow Jones Averages

The Dow Jones Averages are a series of indices that are the most closely followed in US markets (and probably globally).

This is unfortunate as these indices are seriously flawed. Given these flaws in the index, it may be preferable to use alternatives such as the S & P 500.

The best known of the Down Jones Averages indices is the Dow Jones Industrial Average, often abbreviated to DJIA. It is often referred to as the Dow Jones or simply "the Dow". The other two Averages are the Transportation and Utility averages. They are obviously sector indices.

The publisher of the DJIA, Dow Jones Indexes, also publishes a number of other indices.

The most serious flaw of the Averages is that they are not market cap weighted but price weighted. The method used to calculate the index consists of little more than adding share prices together and dividing by factor that is adjusted to reflect changes in the constituents of the index and certain corporate actions such as scrip issues and demergers.

The problem with this is that a movement of the same proportionate size (e.g. a 10% fall) in the price of a company with a higher share price will have a greater impact on the index. This contrasts with more modern equity indices that weight the impact companies have on the market by their market cap.

The other flaw in the index is that there is no consistent method for choosing and reviewing the constituents of the index: they are selected by the editors of the Wall Street Journal and rarely changed.

This leads to the question of why such a flawed index as the DJIA is so widely followed and distributed.

The minor part of the answer is the length of time over which the Dow provides data. It provides a continuous series of index values from 1896 onwards. However, while this is very useful for purposes such as academic studies of long term returns, it has little relevance to most investors.

The main reason for its dominance is simple inertia. The Dow has enormous mind share: it is the one US index that almost everyone has heard of. There is a whole branch of technical analysis known as "Dow Theory", the name appears in the titles of books and Dow index levels are widely reported by the media.

More information is available on on the Dow Jones Indexes website.

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