How the Dow Jones average works

The Dow Jones industrial average, an index of 30 U.S. blue-chip stocks, is the oldest barometer of the stock market. On Friday, it jumped above 17,000 for the first time in its 118-year history.

What is it?

The Dow is a group of 30 big corporations, nearly all of them household names, and its dips and jumps during the trading day reflect changes in their share prices. Its exclusive roster runs from American Express to Walt Disney. Other indexes, such as the Standard &Poor’s 500, open their doors to many more companies, providing a better overall picture of the market’s performance.

The Dow may not be the best measure, but the oldest index remains the best-known shorthand for the stock market.

Beginnings

In the late 19th century, following a number of bubbles and busts, most investors considered the stock market a dangerous place. Charles H. Dow created his index, in part, to make the market easier to understand.

The original Dow Jones industrial average had 12 big businesses including American Cotton Oil, National Lead and Laclede Gas Light Co. Dow first published his average on May 26, 1896; later that year, The Wall Street Journal began running it in the daily paper.

A select group

The number of companies making up the index expanded to 20 in 1916 and then to 30 in 1928. The number has remained the same since then, though the cast of characters changes every few years. Last September, Goldman Sachs, Nike, and Visa replaced Alcoa, Hewlett-Packard and Bank of America.

Entry is restricted to a company that “has an excellent reputation, demonstrates sustained growth and is of interest to a large number of investors,” according to the Dow’s managers.

Longest-standing member

General Electric Co. is the only remaining original member. The industrial giant dropped out of the average for brief spells but returned for good in 1907.

Best days

The Dow’s biggest point jump was on Oct. 13, 2008, when the average soared 936.42 points, or 11 percent, to close at 9,387.61. That followed the announcement of a European plan to bail out financial institutions.

Its biggest percentage jump was more than 15 percent when it reopened on March 15, 1933, during the Great Depression. The newly inaugurated President Franklin D. Roosevelt had shut down the banking system earlier that month. During this extended bank holiday, Congress passed a law to shore up the financial system and Roosevelt created the country’s first insurance for customer’s bank deposits.

Worst days

The Dow’s biggest point drop came on Sept. 29, 2008, when the average lost 777.68 points, or 7 percent. That was the day Congress rejected a plan by the George W. Bush administration to bail out the financial industry.

In percentage terms, the Dow’s biggest drop was on Oct. 19, 1987, when it fell 508 points, or almost 23 percent, to close at 1,738.74. An overvalued stock market and expectations of rising interest rates combined with computerized trading to create that crash, known as Black Monday.

Record low

The Dow’s lowest level was 28.48, reached on Aug. 8, 1896, two and a half months after the index was started.

Who owns it

The Dow Jones industrial average is no longer run by Dow Jones, the media company that publishes The Wall Street Journal. (Rupert Murdoch’s News Corp. bought Dow Jones in 2007.) The index is calculated and published by S&P Dow Jones Indices, a joint venture company that is majority-owned by the publishing giant McGraw-Hill. CME Group and Dow Jones hold smaller stakes.

What moves

A $1 change in any Dow stock is equal to a move of 6.42 points for the Dow. In other words, if one blue chip rose $1, and the 29 other companies sat still, the Dow would increase 6.42 points.

Equal weight

The Dow is a price-weighted index. Most other indexes account for a company’s overall market value, which is found by multiplying the number of shares outstanding by the stock price. For the Dow, the price is all that matters. So, a $1 rise in the price of AT&T’s stock will have the same impact on the index as a $1 gain for Nike, even though AT&T’s value is worth more than two Nikes.

The Standard &Poor’s 500 index accounts for a company’s market value, making it a more accurate reflection of the market. As a result, mutual funds use it as a benchmark for their performance instead of the Dow.

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