What Does a Dow Jones Point Drop Mean?

by Chirantan Basu

    The Dow Jones Industrial Average, commonly known as the Dow Jones index or just the Dow, tracks 30 large U.S. companies across all industries, except for transportation and utilities. The Dow is a price-weighted index, which means that the weight of each stock in the index is proportional to its price. Changes in the Dow index mean increases or decreases in the share prices of any combination of the Dow stocks. The Dow Jones Industrial Average often sets the tone for other major market indexes.

    The Dow is recalculated continuously throughout each trading session. The index had 12 stocks when Charles Dow, founder of Dow Jones & Company, established it in 1896. At that time, the index value was a simple average -- sum the market price of the stocks and divide by 12. Today, the average is no longer a simple division by 30. Rather, the adjusted divisor takes into account stock splits, mergers, substitutions and other changes over the years. According to the "Dow Averages Hour by Hour Performance & Volume" section on The Wall Street Journal's Market Data Center website, this divisor was 0.12914682 on Aug. 31, 2012. This means that a one-point drop in the Dow was roughly equal to only a 13 cent drop in the combined market price of the Dow stocks.

    The Dow Jones Industrial Average does not reflect the entire stock market. However, by constantly calculating the changes in the market prices of leading companies, the index accurately reflects the performance of most publicly-traded companies. In fact, the Dow price chart closely tracks that of broader indexes, such as the S&P 500 and the Dow Jones U.S. Total Market Index. A decrease or increase of just one point represents a small percentage change, but when these changes occur over days and weeks, the effect on portfolio values can be substantial. Professional investment managers use the Dow and other indexes as benchmarks to assess the performance of mutual fund and other institutional portfolios.

    Market indexes reflect the volatile nature of stocks. Price swings of several hundred points, sometimes in the same day, are common. Successful investors ignore short-term market volatility and focus on the fundamentals of their investments. They diversify across different assets, such as stocks and bonds, and in different securities within each asset category. They use market corrections to pick up quality stocks at bargain prices and take profits when stock prices rise too high too quickly.

    You can mimic the performance of the Dow and other indexes by holding index mutual funds or exchange-traded funds, which trade just like stocks. If the Dow rises or drops one percent, the corresponding index mutual funds and ETFs will also rise or drop by about one percent. The ETF that tracks the Dow index trades under the ticker symbol "DIA" on the New York Stock Exchange.

    About the Author

    Based in Ottawa, Canada, Chirantan Basu has been writing since 1995. His work has appeared in various publications and he has performed financial editing at a Wall Street firm. Basu holds a Bachelor of Engineering from Memorial University of Newfoundland, a Master of Business Administration from the University of Ottawa and holds the Canadian Investment Manager designation from the Canadian Securities Institute.

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