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Wednesday, June 10, 2009

The New Dow: How the DJIA is Calculated

As recently posted on my blog is an Excel spreadsheet which calculates the Dow Jones Industrial Average. For those who are finding this for the first time, I will repeat some of the introductory part of the article below.

Many times I've heard people say why is the Dow Jones Industrial Average (DJIA) so much higher than the S&P 500, when the DJIA consists of just 30 stocks and the S&P 500 consists of 500? The answer to this is quite easy and just takes a little calculating. The Dow Jones Index is weighted unlike the S&P 500. The S&P 500 is weighted by market cap; the larger the stock the more affect it has on the daily move of the S&P index. However the DJIA has a weighting so that a 1 point move in any of the 30 stocks will move the index by an equal number of points. To understand this you need a quick history lesson. In 1896 to be exact the index consisted of just 12 stocks, and to get the average back then all you'd need to do is divide the total price of all 12 stocks by 12... Easy isn't it! As you may know it is not that easy, and this is not how you get the average. Over time stocks were added and taken out of the index, as well as stock splits and spinoffs, etc... In order to keep the DJIA consistent the "divisor" must also change. The current divisor is published on page C4 of the Wall Street Journal daily.

UPDATE:

However Monday June 8, 2009 the Dow was changed. Both the Divisor and two of the components were changed; Citigroup (C) and General Motors (GM) were replaced by Travelers (TRV) and Cisco (CSCO). The current divisor as of June 10, 2009 is 0.132319125.

To get an idea of what this means we'll divide 1 point by the divisor and we get 7.5575. This means that a 1 point change in any of the 30 stocks will move the index up/down by 7.5575 points. For example we'll say that 28 of the 30 Dow components finish the day unchanged but Bank or American (BAC) and Caterpillar (CAT) both moved higher by 1 point, we could calculate the index average change by dividing 2 (total move of the stocks added together) by the divisor... The index would move higher by 15.12 points on this day. Since all of the 30 Dow stocks are weighted so that a one point change affects the index equally, one would have to take the sum of all 30 stock prices in the Dow index and divide by the Dow divisor. However this does not take into account the larger priced stocks in the index such as International Business Machine (IBM) which may affect the overall point change greater than the lower priced stocks. This is illustrated by showing that a 1% move in IBM and a 1% move in BAC. A 1% move in IBM (108.35 per share as of close June 10, 2009) would put the index higher by 8.19 points, while a 1% move in BAC (11.98 as of close June 10, 2009) would put the index higher by 0.91 points. As you can see the lower the price of the stock the less affect it has on the index change.

I have designed an Excel spreadsheet of the Dow 30 components, their point and % composition of the index, and how it would affect the Dow Jones Index if any given security in the Dow went to 0. You will also see from this spreadsheet what the 52 week high and 52 week low for the index would be if all 30 components were simultaneously at their 52 week high or 52 week low (extremely unlikely). As of June 10, 2009 the total sum of all 30 Dow stock prices is equal to 1156.34, which when divided by the current divisor will give you the close price 8739.02. You can constantly update the spreadsheet I have designed by clicking the “data” tab, and “refresh all”. The resulting change in the Dow Index column is not always 100% accurate; this is because sometimes websites or other publications report the prices of the DJIA components as a composite of all the exchanges rather than just the price from that company’s primary exchange. However, the point composition for each component and their sum is always accurate. It is recommended that you have Excel 2007. Some have run into problems downloading with Internet Explorer so Firefox or Google Chrome is recommended.

Click here to download the Excel spreadsheet.

Click here to download the Excel spreadsheet for Microsoft 97-2003.

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