Trading on the Dow Jones industrial average – the US 30 or Wall Street for short – is just like trading on the S&P 500. Only it’s not; and for anyone trading on the Dow it’s vital to understand the idiosyncrasies of this stock market index.

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What is the Dow Jones?

 

The Dow Jones industrial average (DJIA) is a price-weighted index of 30 of the largest companies in the US. The index was first devised by Charles Dow in 1896 with 12 stocks. It expanded to 30 in 1928. General Electric is the only survivor from the first iteration of the index, which has evolved slowly over the last century to reflect the changes on Wall Street. Apple, which joined in 2015, is the latest addition.

How does Dow weighting work?

 

The Dow is unique among large indices in that its weighted on share price rather than market capitalisation. This means that the Dow does not really reflect the fortunes of the largest firms, let alone the real economy.

For example, as of January 25th 2017 – the day that the Dow breached 20,000 for the first time – Goldman Sachs accounted for 8% of the index value. Or, around 1,600 points of the index is down to Goldman. Therefore moves in the price of Goldman Sachs stock produce a vastly outsized effect on the index as a whole. Goldman Sachs only joined the index in 2013, when it joined Nike and Visa in replacing Bank of America, Alcoa and Hewlett-Packard.

By contrast, General Electric made up just over 1% of the index weight. That is despite possessing a market cap that is three times that of Goldman.

The importance of this imbalance cannot be overstated as the rise and fall of the Dow is to closely tied to the performance of a small band of companies. Goldman Sachs, IBM and 3M total a full 20% of the index.

No.

Stock

% Weight in the Index

1

Goldman Sachs

8.1

2

IBM

6.08

3

3M

6.03

4

Boeing

5.71

5

UnitedHealth Group

5.5

6

Home Depot

4.69

7

Apple

4.16

8

McDonalds

4.16

9

Travelers

4.02

10

Chevron

4

11

Johnson & Johnson

3.85

12

United Technologies

3.79

13

Disney

3.69

14

Caterpillar

3.35

15

Procter & Gamble

2.97

16

JPMorgan Chase

2.94

17

ExxonMobil

2.91

18

Visa A

2.86

19

American Express

2.62

20

Dupont

2.62

21

Wal Mart

2.28

22

Microsoft

2.17

23

Merck

2.08

24

NIKE B

1.84

25

Verizon Communications

1.7

26

Coca-Cola

1.44

27

Intel

1.29

28

Pfizer

1.07

29

Cisco Systems

1.05

30

General Electric

1.04

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