Explanation of the Dow Jones

by Sara Melone ; Updated July 27, 2017
The dow jones industrial average can affect the stock market.

The Dow Jones is up one minute and it's down the next minute. The Dow Jones Industrial Average can affect our stocks, our investment portfolios and our economy as a whole, but many of us do not understand how the Dow Jones manages to do all this.

What is the Dow?

The Dow, the Dow Jones, the DJIA or the Dow Jones Industrial Average is considered a reference point for determining the overall health and state of the United States economy. This economic reference point as established by the Dow Jones can change on a daily, hourly and even on a minute-by-minute basis, as world news and events move the Dow up or down. The United States stock market consists of three main indicators that track market movement and includes the NASDAQ Composite, the Dow Jones Industrial Average and the Standard & Poor's 500. Of those three, the Dow is generally considered to be the more accurate indicator of current market movements, but it receives criticism as an accurate reflection of the market as whole based on the limited representation of market segments within the Dow.

What Makes up the Dow

The Dow Jones Industrial Average is a composite of 30 of the most popular and commonly traded companies within the United States Stock Market. According to FreeFromBroke.com, at its original inception in 1896, the Dow Jones Industrial Average was composed of a total of only 12 companies. Of those original 12 companies, only the General Electric Corporation was able to remain in the Dow Jones average through the over 100 years since the Dow's inception.

How it Works

Each of the companies that make up the Dow Jones Industrial Average has a stock price that investors pay for the opportunity to purchase stocks in the company. The price of the company stock fluctuates up and down throughout the trading day as investors buy and sell the stocks. In theory, the Dow Jones Average is determined by adding up the total stock prices of each company listed on the Dow Jones and dividing that total by the number of companies to obtain the final Dow Jones Average. Today, some alterations are made to account for matters such as company stock splits. For more details on the Dow Divisor and how the average is calculated, please visit http://www.stockkrios.com/dow_jones_history.php

Importance of the Dow

The Dow is often looked at by both amateur and professional stock market investors to help make investment decisions. Because the Dow is a representation of many of the largest U.S. companies, fluctuations in the Dow figures notes changes in many large U.S. corporations. These fluctuations can indicate high levels of growth and profits in the U.S. economy, or they may signify losses and potential market fallout. A declining Dow may frighten investors who withdraw money from the stock market and further exacerbate dwindling markets.

Reliability of the Dow

Although the Dow can be used as a fairly accurate representation of the market conditions, it does not always tell the complete picture, since it tracks only a handful of the many stocks traded on the stock market exchange in the U.S. Other stock sectors may be thriving even when the Dow is lower, and the opposite may also be true. The Dow is an investing tool rather than a definitive predictor.

About the Author

Sara Melone is a mother of three and a graduate of UNH. With prior careers in insurance and finance, photography, as well as certifications in fitness and nutrition, Melone draws directly from past experience and varying interests. She contributes with equal passion to birth journals, investment blogs, and self-help websites.

Photo Credits

  • stock market analysis screenshot image by .shock from Fotolia.com