The Dow Jones Industrial Average (DJIA) is the best-known stock market index in the United States. It tracks the performance of 30 large and mid-sized companies that make up the Dow Jones Industrial Average.
The index was created in 1896 by Charles Dow and Edward Jones and is often referred to as “The Dow.” The index is often used as a benchmark by investors and traders. And, if you’re wondering how to trade the Dow Jones Industrial Average, we’ve got all the details you need here.
What is the Dow Jones Industrial Average Index?
The Dow Jones Industrial Average Index is a stock index that keeps track of more than thirty large companies based in the United States. The index was established in 1896 and is among the oldest stock indexes, and its performance is considered an indicator of a healthy US stock market.
The S&P Jones Indices manages the Dow Jones Index. S&P Jones is a joint venture and is largely controlled by S&P Global. The Dow Jones index isn’t only a representative of industrial stocks; it also represents stocks from other sectors. However, stocks from the transportation and utility sector are not part of the index.
Can The Dow Jones Stock be bought?
There is no way you can buy the shares of Dow Jones yourself; however, you can access a portfolio exposure linked to the index’s performance and the companies that are part of the index. These are your options of investment:
Buy shares all of the companies (30) listed in the Dow Jones Index
With only thirty registered companies in the Dow Jones index, it is feasible to purchase their stocks. You can even buy partial shares, as most brokers don’t charge trade commissions, and some may even allow fractional share investments. This investment approach will require you to manage up to thirty stocks and change your portfolio if the index changes.
Buy shares in a ‘Dow-focused’ ETF
ETF (Exchange Traded Funds) that keep track of the Dow index and especially its performance, such as the SPDR Dow Jones Industrial Average ETF, provide portfolio exposure to the companies registered with the Dow index.
Buying ETF shares is similar to investing in the thirty companies separately, and you are not required to change your portfolio.
Invest in Dow Options or Future Contracts
You can invest in Dow options contracts through the global market of CBOE (options exchange). You can also purchase Dow futures contracts through the Chicago Mercantile Exchange (owned by CME). These securities are perfect for investors that are experienced and have market knowledge.
The Dow Jones Industrial Average is a good place to start for investors who need portfolio exposure that can offer a wide range of sectors through large-cap stocks. Dow Jones Industrial Average is just the place for you if you are looking to invest in Blue-chip firms, which are usually profitable and stable.
A Short History about Dow Jones Industrial Average
The Dow Jones Industrial Average was formed on 26th May 1896 by Charles Dow, who worked in the Wall Street Journal. Charles Dow is also the founder of the Dow Jones and Company (in 1882) and journalists Charles Bergstresser and Edward Jones.
At first, the Dow Jones Industrial Average had twelve companies registered on the index, and most of them belonged to the industrial sector. However, with time, the motives of the index evolved as it shifted its approach from the industrial sector to gauge the health of the entire American stock market. Since 1928, the index has been keep track of thirty companies.
Registered Companies in the Dow Jones Industrial Average
These are the thirty registered companies:
- American Express
- 3M
- Apple
- Amgen
- Boeing
- Caterpillar
- Cisco Systems
- Coca-Cola
- Chevron
- Dow
- Disney
- Goldman Sachs
- Honeywell International
- Home Depot
- IBM
- Johnson & Johnson
- Intel
- Merek
- Mc Donald’s
- JPMorgan Chase
- Microsoft
- Protector & Gamble
- Nike
- Salesforce
- Traveler
- Visa
- Verizon
- Walmart
- UnitedHealth Group
- Walgreens Boots Alliance
How to Calculate the Value of the Dow Jones Industrial Average?
Most stock markets are dependent on market capitalization: share price X number of outstanding shares, the Dow Jones Industrial Average index is dependent on the price. Therefore, the Dow Jones Industrial Average value can only be obtained by calculating the stock prices of the thirty registered companies.
However, calculating that average value is not straightforward; you can’t just total all the companies’ stock prices and divide it by thirty. The mathematics is complicated by stock splits, mergers, spinoffs, and other developments. A committee is required to determine the ‘Dow Divider,’ which is the denominator by which the thirty share prices are divided.
On 31st March 2021, the value of the Dow Divider was 0.159871, and by using this value, you can calculate the value of the Dow Jones Industrial Average. To calculate, total up the share value of all the thirty companies and divide them by the Dow Divider value.
While changes in the share prices of any company registered with the index impact the value of the index, Charles Dow’s vision was that based on percentages, the movement of stocks that have a higher price have the greatest impact on the value of the index.
An example of this can be, as of 31st March 2021, the stock with the highest price belonged to the UnitedHealth Group, which traded at $ 372.07. The stock with the lowest price belonged to Cisco; it traded at $ 51.71. With the stock price of UnitedHealth 7.2 % higher than Cisco’s, the share price of Cisco will have to change by the same percentage to have any impact on the overall value of the index.
Dow Jones Industrial Average, S&P 500, and the NASDAQ Composite
The Dow Jones Industrial Average is not the only index in the market; there are two more. The other two indexes are:
- S&P 500
- NASDAQ
These three indexes are used to measure the performance of the stock market. For example, the S&P 500 index contains 500 large-capitalization stocks picked through certain criteria, such as profitability and market capitalization.
The NASDAQ index contains over 2500 shares, and unlike Dow and S&P 500, the NASDAQ is market-capitalization weighted, which means companies with the greatest value have an impact on the index.
The bulk of shares in the NASDAQ and S&P 500 indexes belong to technological firms, and NASDAQ has the most technological exposure among the three indexes. Giants of technology such as Amazon, Tesla, Facebook, and Alphabet are part of NASDAQ and S&P 500.
Most investors and traders are more interested in the S&P 500 index, as it contains a broad array of stocks and is market-capitalization-weighted. The S&P 500 index is also regarded as a more accurate health indicator of the stock market than the Dow index.
Even though the Dow index might not be as vast as the NASDAQ and S&P 500 indexes, the index is still a great indicator of the stock market’s functions, health, and directions.
Futures Contract
A futures contract is when two parties sign an agreement to buy or sell an asset at a specific price on a future date. For example, one party agrees to purchase an asset on a specific date, while the second party agrees to sell the asset on the date decided. The two parties already agree upon the price of the asset.
Usually, these agreements take place over standard commodities such as:
- Bonds
- Oil
- Gold
- Wheat
- Price of a stock index
The futures agreement is always made on commodities that are regulated. However, one thing that is important to keep in mind is that some commodities (oil, gold, wheat) can be delivered, whereas other commodities (index futures) can be converted into cash.
What is an Option?
Generally, options are of two types: a put and a call. It is important to understand the difference between options, allowing you to use them better. When someone buys an option, they have to pay a premium to the seller. Although this is not considered an obligation, this payment will give the buyer the right to buy or sell the underlying assets.
Similarly, there are two major components for options trading: a buyer and a seller. Traders willing to bear the risk sell a significant amount of options, and they collect a premium on it. However, the traders’ premium is considered a liability in most cases unless the options either expire or are bought back.
Call Options
Call options allow the buyer to have the right to buy an underlying asset at a certain strike price and within a specific time. The seller must deliver a long position in underlying contracts in the future if the buyer decides to exercise the call option. If the call option expires, the seller will be forced to take a short position in the market.
Put Options
Put options allow the buyer the right to sell underlying assets at a certain strike price within a specific time. If the buyer chooses to exercise the option, the seller must deliver a short position from the strike price.
Conclusion
Our main emphasis of this article was the Dow Jones Industrial Average index, and we thoroughly discussed all aspects of the index. In addition, we shed light on the formation of the index, its owners, its importance, its role in the stock market, and whether you can directly invest in the index or not.
We concluded by comparing the three biggest indexes: Dow, NASDAQ, and S&P 500. While S&P 500 and NASDAQ have a broader array of stocks, Dow still has relevance in the market as an indicator of market functions and directions.
We ended the article by discussing the futures contracts and options relevant when it comes to indexes.