7 ms·

Why the Dow is a useless market index

129 points by qwerty2020 10y ago

obblekk 10y ago
tldr: The Dow 30 index is a bit absurd, however it's not as bad as it seems because of portfolio theory. The Dow 30 correlates highly with the S&P500 index over medium-long periods of times (approx more than a month) [1]. This correlation is due to the fact that the 30 stocks that are selected are arbitrary but not random. They are selected by a human process which considers which companies contribute an important factor to the overall market [2]. Of course this process will be imperfect because it's vague, however it gets pretty close. Don't forget, according to findings from portfolio theory, it's possible to replicate an index with only a small subset of the components of that index [3]. There's a whole field of work describing how to do this [search google for 'replicating index'], In fact, replicating an index with a small number of stocks is exactly how 'smart trading' companies like wealthfront and bettermint make money. They find multiple non-overlapping subsets of the S&P500 which correlate strongly with S&P500 performance. Then they buy subset A, and if a loss is incurred in any month, they sell subset A and buy subset B. Since A and B are highly correlated with each other (ideally r>.99) and with the S&P500, the investor should expect the same return in the future, however can book a capital loss which creates a tax refund. Shifting from subset A to subset B avoids a wash-sale allowing the capital loss to be recognized [4]. The Dow 30 is certainly not an optimal index, however it's a case study in showing how selecting the "top" companies for some reasonable definition of "top" will earn a return approx. equal to the market (represented by S&P500) no matter the strategy (in this case price-weighting instead of mkt cap weighting can be considered a strategy). The reason it's cited so widely is that there's a lot of historical data on the Dow 30, whereas every other index is less reported. [1] Yahoo Finance comparison of Dow 30 vs. S&P500 chart http://finance.yahoo.com/chart/%5EDJI#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%3D http://finance.yahoo.com/chart/%5EDJI#eyJjb21wYXJpc29ucyI6Il... [2] Dow 30 index is built and maintained by a subsidiary of News Corp. https://en.wikipedia.org/wiki/S%26P_Dow_Jones_Indices https://en.wikipedia.org/wiki/S%26P_Dow_Jones_Indices. [3] http://www.etf.com/etf-education-center/21038-how-to-run-an-index-fund-full-replication-vs-optimization.html http://www.etf.com/etf-education-center/21038-how-to-run-an-... [4] http://www.investopedia.com/terms/w/washsalerule.asp http://www.investopedia.com/terms/w/washsalerule.asp
- qwerty2020 10y ago
  Agree that the Dow 30 correlate reasonably well to the larger market, but it's the price-weighting piece I have a major problem with. You have to admit that the index would be better off weighing its components based on actual market value rather than share price. Fortunately, as the scatter plot shows, the under/over representation isn't that bad, but still ridiculous for the most widely cited market index nonetheless.
  - teslacar 10y ago
    That is what the S&P 500 does. No one stopping anyone from buying the individual stocks of the Dow in a market-cap weighted manner
- deleted 10y ago
  [deleted]
- loeg 10y ago
  That isn't how the robo-advisors actually implement tax-loss harvesting. They just buy slightly different index funds.[0] E.g., VTI vs SCHB. VTI tracks the "CRSP US Total Market" index, while SCHB tracks the "DJ Broad US Market" index (note, this is not the same thing as the DJIA). Those indices are not comprised of disjoint subsets of the total stock market. Additionally, large index funds have enough capital to just buy all of the components (100s-1000s) without sampling. Thirty funds doesn't really do it justice. It can also miss out on big winners, which is where lots of growth comes from.[1] [0]: https://research.wealthfront.com/whitepapers/tax-loss-harvesting/ https://research.wealthfront.com/whitepapers/tax-loss-harves... [1]: http://www.efficientfrontier.com/ef/900/15st.htm http://www.efficientfrontier.com/ef/900/15st.htm
  - obblekk 10y ago
    I believe this is not allowed by the IRS because ETFs tracking similar indices would be considered 'substantially identical', but I'm not sure [1]. If it is allowed, then you're right - this would be the most efficient way to implement tax loss harvesting. A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale you: 1. Buy substantially identical stock or securities, 2. Acquire substantially identical stock or securities in a fully taxable trade, 3. Acquire a contract or option to buy substantially identical stock or securities, or 4. Acquire substantially identical stock for your individual retirement account (IRA) or Roth IRA. [1] https://www.irs.gov/publications/p550/ch04.html#en_US_2016_publink100010601 https://www.irs.gov/publications/p550/ch04.html#en_US_2016_p...
netcraft 10y ago
Ive heard similar complaints for years and it makes sense to me - what doesn't is why alternatives arent used or created? I don't understand everything about stock markets or certainly their politics but it seems on the surface that if you had a better indicator of the economy itd be pretty easy to show its usefulness. And with historical data you should be able to replicate a new index and measure its effectiveness.
- loeg 10y ago
  The S&P500 is a fine index. People just use that instead.
employee8000 10y ago
It's not ideal but to call it useless is arrogant and immature. It's a decent indicator of how the blue caps are doing in the markets. SP500 is arguable better but the DJI isn't useless.
- unabridged 10y ago
  No Google, No Amazon. Its an arbitrary choice of 30 companies out of the top 100 market caps based mostly on stock price and whose friends are on the board. I think Hacker News could come up with a better list of 30 stocks with market cap over $30B.
  - employee8000 10y ago
    You're not disagreeing with what I wrote.
schwarrrtz 10y ago
Relevant episode of Planet Money: http://www.npr.org/sections/money/2017/01/04/508261371/episode-443-dont-believe-the-hype http://www.npr.org/sections/money/2017/01/04/508261371/episo... "It's no secret that we here at Planet Money think the Dow is a terrible economic indicator. We don't like that it only looks at thirty companies. We don't like the way it does its math. We think it does a bad job reflecting the overall economy. Honestly, we're not sure why everyone is still talking about it."
- paulpauper 10y ago
  Terrible? Hyperbole. The 30 companies are pretty big and relevant, so still it works out well. Also, the DJIA pays a sightly larger dividend than the S&P 500. Also it's not an economic indicator.
  - kcanini 10y ago
    > it's not an economic indicator Can you explain this statement? It's almost synonymous with the stock market, and is one of the most common headline numbers that people mention in business and economy news reports.
    - acchow 10y ago
      The stock market is not the economy.
      - pyromine 10y ago
        Capital markets are crucial indicators of economic activity
        milesrout 10y ago
        Only because we use them as indicators of economic activity. When stock markets plunge people panic and that panic is what causes economic instability. That's what causes issues. Economics is purely a product of human minds acting in unison or opposition.
pk3 10y ago
I wouldn't go so far as to call it useless - anachronistic perhaps, but useless no. When the Dow was first calculated, real time market capitalization for individual companies wasn't a thing. Prevailing market price was a decent enough proxy that Charles Dow could make an index of leading industrial firms out of prices (and price changes) alone. As others have pointed out, over a long enough time period the Dow Jones has a high correlation with market cap weighted indices. Its annual volatility has been about 1.5 percentage points more a year, but average returns over any reasonable holding period are barely different than, say, the S&P 500. There's an even better argument against the Dow than the price weighting though - the somewhat arbitrary company inclusions. One of the more interesting pieces of history is IBM's 40-year 'vacation' from the Dow. If IBM had stayed in for the 40 years after 1939 you could tack on another 5 figure number to today's index price.
- umanwizard 10y ago
  > When the Dow was first calculated, real time market capitalization for individual companies wasn't a thing How is this possible? People were buying shares without knowing what fraction of the company they represented ??
  - twblalock 10y ago
    They had a good estimate, but not in real time. All of the information was delayed.
    - umanwizard 10y ago
      (As I said on the other comment) wouldn't that also apply to prices?
      - twblalock 10y ago
        Yes. It still does, actually, but on a much shorter delay. If you make a market buy order with an online broker, it will execute pretty much instantly, but the price might have fluctuated between the time you pressed the button and the time the order was filled. It usually makes little difference, but people have ended up paying a lot more than they expected on some rare occasions. This is common enough with ETFs that some brokers advise their clients to always use limit orders.
nabla9 10y ago
>So, next time you hear someone talk about the Dow in any serious sense, kindly point them in the direction of an index weighted by market capitalization (e.g. S&P 500 or Wilshire 5000), The most commonly used index - the one that is shown in the news or discussed with your Uber driver. should be index that provides essential information for the average person. I would advocate pointing people towards total return indexes of S&P 500 or Wilshire 5000. Index's total return displays a more accurate representation of the index's performance than price index and it can be used directly to benchmark stocks to other investments. Surprising amount of people are not aware that stock price index is not accurate measurement of stock market performance over longer periods of time. http://imgur.com/a/uHRZ9 http://imgur.com/a/uHRZ9
- gumby 10y ago
  > The most commonly used index - the one that is shown in the news or discussed with your Uber driver. should be index that provides essential information for the average person. Seriously, why? Those discussions are no different from discussion of sports scores, and equally as relevant to the decisions people make. So who cares if they are talking baseball, the dow, sunspots, or astrology? Or Apple vs android? (BTW I realized the Dow indices are nonsensical as a teen ager, so am not defending them in the slightest)
  - nabla9 10y ago
    It's very important when people save for retirement and think about different investment options. There are all kinds of invest in gold snake oil salesmen around.
    - gumby 10y ago
      But they shouldn't be managing their investments on a day-to-day bases much less basing decisions on conversations with random uber drivers.
  - bluetwo 10y ago
    The big difference is that you can buy a low-cost S&P 500 fund, and this is a perfectly reasonable thing to have in your retirement account. You will know, therefore, if the SP500 index goes up 1%, your retirement fund has done nearly the same.
teslacar 10y ago
Not sure how this got to the front page. This is not new information or even that interesting. Literally, hundreds of articles about this exact same thing https://www.google.com/webhp?sourceid=chrome-instant&ion=1&espv=2&ie=UTF-8#q=dow+jones+price+weighted https://www.google.com/webhp?sourceid=chrome-instant&ion=1&e... another brand new site up-voted to the font page...created in 2017 and only 8 very sparse articles erikrood.com
Animats 10y ago
The DJIA is just the sum of 30 stock prices, divided by a "divisor" which is adjusted to keep the value constant when a company is added or removed. The amazing thing is that it's quite useful. But why? One reason is a long-standing tradition that stocks should be priced in the range 10 to 100. This tradition stems from old ticker system limitations, and it's weaker than it used to be, but it still has some force. Stocks which get well above 100 usually split (yes, there's BRK), and stocks which get below 10 are usually considered to be in trouble. Below 1, they're called "penny stocks" and get delisted from the big exchanges. As a result, successful companies tend to be near the top of the 10-100 range. This weights them higher in the DJIA. Right now, here's the list.[1] Goldman Sachs is the only one above 200, and they really ought to split. They might get replaced in the DJIA if they don't. Nobody is below 10; GE, at 23, is at the bottom. [1] http://money.cnn.com/data/dow30/ http://money.cnn.com/data/dow30/
- crazygringo 10y ago
  Fascinating. Thinking about how GOOG is $824 right now, and how it's not in the Dow, I found: "This quirk kept Apple from joining the index until recently. The world's biggest tech company, despite its massive influence on the economy and the markets, was excluded from the Dow Jones Industrial Average because its share price of about $600 would have given it outsize influence on the index. However, when the company split its stock 7-for-1, it became a viable Dow addition." [1] [1] https://www.fool.com/investing/general/2015/05/18/the-30-dow-jones-stocks.aspx https://www.fool.com/investing/general/2015/05/18/the-30-dow...
TheAlchemist 10y ago
That's the reason why Berkshire Hathaway is out of the index, while based on the market cap, it should clearly be in (~400B). That being said, the correlation between DIJ and S&P is close to 100% so for all practical reasons (from a long term investor point of view) it should be OK.
hl5 10y ago
I guess all the Dow futures and options traders should just pack up and go home? Dow trading is as useful as any index with volume in analyzing herd behavior. It's a far better prospect than analyzing any of it's individual components in isolation.
gigatexal 10y ago
Yup. Completely useless index.
ChuckMcM 10y ago
It is nice to see someone dig deeply into what the numbers actually mean, but it is surprising to see them come away with the wrong conclusions. The DOW isn't useless, look at this graph : https://www.google.com/finance?chdnp=1&chfdeh=0&chdet=1491778123622&chddm=502044&cmpto=INDEXDJX:.DJI;INDEXSP:.INX;INDEXNASDAQ:.IXIC&cmptdms=0;0;0&q=INDEXDJX:.DJI,INDEXSP:.INX,INDEXNASDAQ:.IXIC&ntsp=0&ei=HbrqWMm9N8TxjAHv6bvIDg https://www.google.com/finance?chdnp=1&chfdeh=0&chdet=149177... which is a comparison of the DOW, S&P and NASDAQ indices. Note how closely the DOW and S&P 500 track each other? If the DOW was 'useless' as the author surmises, and the S&P 500 is 'better' then why are they so closely correlated? The answer is of course that membership in the DOW (and S&P 500) changes over time. The selection of companies and their weighting is done by people who look at the impact a particular company has and how its stock price 'leads' or 'trails' the market. You pick 30 of those and they become your 'signal' for the health of the market.
- JumpCrisscross 10y ago
  For short distances, the pre-Newtonian "ball flies straight and then drops vertically when it runs out of oomph" math approximates Newton. It's close enough, except when it matters. Unlike Einstein, those conditions arise regularly. It's as easy to calculate Newton as its predecessors. The predecessor is useless. The Dow and S&P 500 are as easy to access. (They're similarly intensive, with a computer, to calculate.) When they diverge, the S&P tells one more. (The Dow only talks to industry, for which the relevant SPDR is better.) It's uselsss. (We loved it on the trading floor, though. Retail would buy based on the Dow. Free profits.)
  - ChuckMcM 10y ago
    > It's uselsss. (We loved it on the trading floor, > though. Retail would buy based on the Dow. Free > profits.) This is almost like the Yogi-ism "Nobody goes there any more, its too crowded." Because in the same sentence you say "its useless" and "it gives you free profits" (which is useful), much like "nobody goes there" and "its too crowded" (hence lots of people do go there). I don't disagree with the assertion that as a trading signal it is useless, there is much better information around where the market is going right now, or perhaps in the short term future. But as an investing signal it serves the purpose well, with fewer stocks than the S&P 500. My parents for example received an inheritance and wanted to invest it, so I suggested an S&P 500 ETF fund. Doesn't cost anything for them to sit on it and when they hear the radio say "The S&P is up 10% for the year so far" they know that their investments are also up about 10% for the year. For a while I had a DOW basket, actually holding shares in the 30 companies in the index. When the DOW hit an all time high I knew my basket of stocks was worth more (as a group) than they had been in the past. Changes in the index did not cause my parents to make trades, instead they just reflected changes in value of that portion of our investment portfolio. And for that it continues to be useful.
dkrich 10y ago
I see a couple of problems with these arguments. First, the assumption that market capitalization is more important for weighting a market index than share price. I'd argue that if your goal is to measure the health of the overall stock market, companies that control the most money should be weighted not much more than less valuable companies. Just because Wal-Mart, Amazon, and Costco are doing great, doesn't mean that JCPenny, Macy's and smaller retailers that employ hundreds of thousands of people are doing great. Giving more weight to smaller companies introduces more companies than just those at the top of the value spectrum. A company with massive resources can probably weather certain negative economic variations better than smaller companies, so to focus solely on those to the exclusion of all others seems to be willfully ignoring a significant part of what comprises the overall market. The other issue is that even though the S&P is cited as being a much better index to track the market, the fact is that the Dow and the S&P correlate almost identically historically. So even if the Dow is reasoned to be much worse than the S&P, history shows that they both reflect basically the same thing.
eb0la 10y ago
Not so useless: you can construct hadge fund-like trading strategies with the DOW and SP500. Both DOW and SP500 have some tendency to go up and down at the same time in bull and bear market times. When this happens you can (for instance) short DOW and long SP500 and your losses in the sort side will be covered by the gains in the logn side... ...but they will be uncorrelated for short periods of time. So, if your short possition goes down while your long is constant or goes down much slower than your short, then you're making money. Probably you can make this kind of hedging with very little money (or almost free) using the fee you get from going short to buy the long leg of the spread.
- tempestn 10y ago
  So all you need to do is predict the future to know which way to go long/short, and... profit!
rdlecler1 10y ago
S&P 500 and the Dow are highly correlated (95% over the past 50 years) and so as an overall temperature of the market it's typically sufficient.

129 points by qwerty2020 10y ago

tldr: The Dow 30 index is a bit absurd, however it's not as bad as it seems because of portfolio theory. The Dow 30 correlates highly with the S&P500 index over medium-long periods of times (approx more than a month) [1]. This correlation is due to the fact that the 30 stocks that are selected are arbitrary but not random. They are selected by a human process which considers which companies contribute an important factor to the overall market [2]. Of course this process will be imperfect because it's vague, however it gets pretty close. Don't forget, according to findings from portfolio theory, it's possible to replicate an index with only a small subset of the components of that index [3]. There's a whole field of work describing how to do this [search google for 'replicating index'], In fact, replicating an index with a small number of stocks is exactly how 'smart trading' companies like wealthfront and bettermint make money. They find multiple non-overlapping subsets of the S&P500 which correlate strongly with S&P500 performance. Then they buy subset A, and if a loss is incurred in any month, they sell subset A and buy subset B. Since A and B are highly correlated with each other (ideally r>.99) and with the S&P500, the investor should expect the same return in the future, however can book a capital loss which creates a tax refund. Shifting from subset A to subset B avoids a wash-sale allowing the capital loss to be recognized [4]. The Dow 30 is certainly not an optimal index, however it's a case study in showing how selecting the "top" companies for some reasonable definition of "top" will earn a return approx. equal to the market (represented by S&P500) no matter the strategy (in this case price-weighting instead of mkt cap weighting can be considered a strategy). The reason it's cited so widely is that there's a lot of historical data on the Dow 30, whereas every other index is less reported. [1] Yahoo Finance comparison of Dow 30 vs. S&P500 chart http://finance.yahoo.com/chart/%5EDJI#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%3D http://finance.yahoo.com/chart/%5EDJI#eyJjb21wYXJpc29ucyI6Il... [2] Dow 30 index is built and maintained by a subsidiary of News Corp. https://en.wikipedia.org/wiki/S%26P_Dow_Jones_Indices https://en.wikipedia.org/wiki/S%26P_Dow_Jones_Indices. [3] http://www.etf.com/etf-education-center/21038-how-to-run-an-index-fund-full-replication-vs-optimization.html http://www.etf.com/etf-education-center/21038-how-to-run-an-... [4] http://www.investopedia.com/terms/w/washsalerule.asp http://www.investopedia.com/terms/w/washsalerule.asp

qwerty2020 10y ago
Agree that the Dow 30 correlate reasonably well to the larger market, but it's the price-weighting piece I have a major problem with. You have to admit that the index would be better off weighing its components based on actual market value rather than share price. Fortunately, as the scatter plot shows, the under/over representation isn't that bad, but still ridiculous for the most widely cited market index nonetheless.
- teslacar 10y ago
  That is what the S&P 500 does. No one stopping anyone from buying the individual stocks of the Dow in a market-cap weighted manner
deleted 10y ago
[deleted]
loeg 10y ago
That isn't how the robo-advisors actually implement tax-loss harvesting. They just buy slightly different index funds.[0] E.g., VTI vs SCHB. VTI tracks the "CRSP US Total Market" index, while SCHB tracks the "DJ Broad US Market" index (note, this is not the same thing as the DJIA). Those indices are not comprised of disjoint subsets of the total stock market. Additionally, large index funds have enough capital to just buy all of the components (100s-1000s) without sampling. Thirty funds doesn't really do it justice. It can also miss out on big winners, which is where lots of growth comes from.[1] [0]: https://research.wealthfront.com/whitepapers/tax-loss-harvesting/ https://research.wealthfront.com/whitepapers/tax-loss-harves... [1]: http://www.efficientfrontier.com/ef/900/15st.htm http://www.efficientfrontier.com/ef/900/15st.htm
- obblekk 10y ago
  I believe this is not allowed by the IRS because ETFs tracking similar indices would be considered 'substantially identical', but I'm not sure [1]. If it is allowed, then you're right - this would be the most efficient way to implement tax loss harvesting. A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale you: 1. Buy substantially identical stock or securities, 2. Acquire substantially identical stock or securities in a fully taxable trade, 3. Acquire a contract or option to buy substantially identical stock or securities, or 4. Acquire substantially identical stock for your individual retirement account (IRA) or Roth IRA. [1] https://www.irs.gov/publications/p550/ch04.html#en_US_2016_publink100010601 https://www.irs.gov/publications/p550/ch04.html#en_US_2016_p...

netcraft 10y ago

Ive heard similar complaints for years and it makes sense to me - what doesn't is why alternatives arent used or created? I don't understand everything about stock markets or certainly their politics but it seems on the surface that if you had a better indicator of the economy itd be pretty easy to show its usefulness. And with historical data you should be able to replicate a new index and measure its effectiveness.

loeg 10y ago
The S&P500 is a fine index. People just use that instead.

employee8000 10y ago

It's not ideal but to call it useless is arrogant and immature. It's a decent indicator of how the blue caps are doing in the markets. SP500 is arguable better but the DJI isn't useless.

unabridged 10y ago
No Google, No Amazon. Its an arbitrary choice of 30 companies out of the top 100 market caps based mostly on stock price and whose friends are on the board. I think Hacker News could come up with a better list of 30 stocks with market cap over $30B.
- employee8000 10y ago
  You're not disagreeing with what I wrote.

schwarrrtz 10y ago

Relevant episode of Planet Money: http://www.npr.org/sections/money/2017/01/04/508261371/episode-443-dont-believe-the-hype http://www.npr.org/sections/money/2017/01/04/508261371/episo... "It's no secret that we here at Planet Money think the Dow is a terrible economic indicator. We don't like that it only looks at thirty companies. We don't like the way it does its math. We think it does a bad job reflecting the overall economy. Honestly, we're not sure why everyone is still talking about it."

paulpauper 10y ago
Terrible? Hyperbole. The 30 companies are pretty big and relevant, so still it works out well. Also, the DJIA pays a sightly larger dividend than the S&P 500. Also it's not an economic indicator.
- kcanini 10y ago
  > it's not an economic indicator Can you explain this statement? It's almost synonymous with the stock market, and is one of the most common headline numbers that people mention in business and economy news reports.
  - acchow 10y ago
    The stock market is not the economy.
    - pyromine 10y ago
      Capital markets are crucial indicators of economic activity
      - milesrout 10y ago
        Only because we use them as indicators of economic activity. When stock markets plunge people panic and that panic is what causes economic instability. That's what causes issues. Economics is purely a product of human minds acting in unison or opposition.

pk3 10y ago

I wouldn't go so far as to call it useless - anachronistic perhaps, but useless no. When the Dow was first calculated, real time market capitalization for individual companies wasn't a thing. Prevailing market price was a decent enough proxy that Charles Dow could make an index of leading industrial firms out of prices (and price changes) alone. As others have pointed out, over a long enough time period the Dow Jones has a high correlation with market cap weighted indices. Its annual volatility has been about 1.5 percentage points more a year, but average returns over any reasonable holding period are barely different than, say, the S&P 500. There's an even better argument against the Dow than the price weighting though - the somewhat arbitrary company inclusions. One of the more interesting pieces of history is IBM's 40-year 'vacation' from the Dow. If IBM had stayed in for the 40 years after 1939 you could tack on another 5 figure number to today's index price.

umanwizard 10y ago
> When the Dow was first calculated, real time market capitalization for individual companies wasn't a thing How is this possible? People were buying shares without knowing what fraction of the company they represented ??
- twblalock 10y ago
  They had a good estimate, but not in real time. All of the information was delayed.
  - umanwizard 10y ago
    (As I said on the other comment) wouldn't that also apply to prices?
    - twblalock 10y ago
      Yes. It still does, actually, but on a much shorter delay. If you make a market buy order with an online broker, it will execute pretty much instantly, but the price might have fluctuated between the time you pressed the button and the time the order was filled. It usually makes little difference, but people have ended up paying a lot more than they expected on some rare occasions. This is common enough with ETFs that some brokers advise their clients to always use limit orders.

nabla9 10y ago

>So, next time you hear someone talk about the Dow in any serious sense, kindly point them in the direction of an index weighted by market capitalization (e.g. S&P 500 or Wilshire 5000), The most commonly used index - the one that is shown in the news or discussed with your Uber driver. should be index that provides essential information for the average person. I would advocate pointing people towards total return indexes of S&P 500 or Wilshire 5000. Index's total return displays a more accurate representation of the index's performance than price index and it can be used directly to benchmark stocks to other investments. Surprising amount of people are not aware that stock price index is not accurate measurement of stock market performance over longer periods of time. http://imgur.com/a/uHRZ9 http://imgur.com/a/uHRZ9

gumby 10y ago
> The most commonly used index - the one that is shown in the news or discussed with your Uber driver. should be index that provides essential information for the average person. Seriously, why? Those discussions are no different from discussion of sports scores, and equally as relevant to the decisions people make. So who cares if they are talking baseball, the dow, sunspots, or astrology? Or Apple vs android? (BTW I realized the Dow indices are nonsensical as a teen ager, so am not defending them in the slightest)
- nabla9 10y ago
  It's very important when people save for retirement and think about different investment options. There are all kinds of invest in gold snake oil salesmen around.
  - gumby 10y ago
    But they shouldn't be managing their investments on a day-to-day bases much less basing decisions on conversations with random uber drivers.
- bluetwo 10y ago
  The big difference is that you can buy a low-cost S&P 500 fund, and this is a perfectly reasonable thing to have in your retirement account. You will know, therefore, if the SP500 index goes up 1%, your retirement fund has done nearly the same.

teslacar 10y ago

Not sure how this got to the front page. This is not new information or even that interesting. Literally, hundreds of articles about this exact same thing https://www.google.com/webhp?sourceid=chrome-instant&ion=1&espv=2&ie=UTF-8#q=dow+jones+price+weighted https://www.google.com/webhp?sourceid=chrome-instant&ion=1&e... another brand new site up-voted to the font page...created in 2017 and only 8 very sparse articles erikrood.com

Animats 10y ago

The DJIA is just the sum of 30 stock prices, divided by a "divisor" which is adjusted to keep the value constant when a company is added or removed. The amazing thing is that it's quite useful. But why? One reason is a long-standing tradition that stocks should be priced in the range 10 to 100. This tradition stems from old ticker system limitations, and it's weaker than it used to be, but it still has some force. Stocks which get well above 100 usually split (yes, there's BRK), and stocks which get below 10 are usually considered to be in trouble. Below 1, they're called "penny stocks" and get delisted from the big exchanges. As a result, successful companies tend to be near the top of the 10-100 range. This weights them higher in the DJIA. Right now, here's the list.[1] Goldman Sachs is the only one above 200, and they really ought to split. They might get replaced in the DJIA if they don't. Nobody is below 10; GE, at 23, is at the bottom. [1] http://money.cnn.com/data/dow30/ http://money.cnn.com/data/dow30/

crazygringo 10y ago
Fascinating. Thinking about how GOOG is $824 right now, and how it's not in the Dow, I found: "This quirk kept Apple from joining the index until recently. The world's biggest tech company, despite its massive influence on the economy and the markets, was excluded from the Dow Jones Industrial Average because its share price of about $600 would have given it outsize influence on the index. However, when the company split its stock 7-for-1, it became a viable Dow addition." [1] [1] https://www.fool.com/investing/general/2015/05/18/the-30-dow-jones-stocks.aspx https://www.fool.com/investing/general/2015/05/18/the-30-dow...

TheAlchemist 10y ago

That's the reason why Berkshire Hathaway is out of the index, while based on the market cap, it should clearly be in (~400B). That being said, the correlation between DIJ and S&P is close to 100% so for all practical reasons (from a long term investor point of view) it should be OK.

hl5 10y ago

I guess all the Dow futures and options traders should just pack up and go home? Dow trading is as useful as any index with volume in analyzing herd behavior. It's a far better prospect than analyzing any of it's individual components in isolation.

gigatexal 10y ago

Yup. Completely useless index.

ChuckMcM 10y ago

It is nice to see someone dig deeply into what the numbers actually mean, but it is surprising to see them come away with the wrong conclusions. The DOW isn't useless, look at this graph : https://www.google.com/finance?chdnp=1&chfdeh=0&chdet=1491778123622&chddm=502044&cmpto=INDEXDJX:.DJI;INDEXSP:.INX;INDEXNASDAQ:.IXIC&cmptdms=0;0;0&q=INDEXDJX:.DJI,INDEXSP:.INX,INDEXNASDAQ:.IXIC&ntsp=0&ei=HbrqWMm9N8TxjAHv6bvIDg https://www.google.com/finance?chdnp=1&chfdeh=0&chdet=149177... which is a comparison of the DOW, S&P and NASDAQ indices. Note how closely the DOW and S&P 500 track each other? If the DOW was 'useless' as the author surmises, and the S&P 500 is 'better' then why are they so closely correlated? The answer is of course that membership in the DOW (and S&P 500) changes over time. The selection of companies and their weighting is done by people who look at the impact a particular company has and how its stock price 'leads' or 'trails' the market. You pick 30 of those and they become your 'signal' for the health of the market.

JumpCrisscross 10y ago
For short distances, the pre-Newtonian "ball flies straight and then drops vertically when it runs out of oomph" math approximates Newton. It's close enough, except when it matters. Unlike Einstein, those conditions arise regularly. It's as easy to calculate Newton as its predecessors. The predecessor is useless. The Dow and S&P 500 are as easy to access. (They're similarly intensive, with a computer, to calculate.) When they diverge, the S&P tells one more. (The Dow only talks to industry, for which the relevant SPDR is better.) It's uselsss. (We loved it on the trading floor, though. Retail would buy based on the Dow. Free profits.)
- ChuckMcM 10y ago
  > It's uselsss. (We loved it on the trading floor, > though. Retail would buy based on the Dow. Free > profits.) This is almost like the Yogi-ism "Nobody goes there any more, its too crowded." Because in the same sentence you say "its useless" and "it gives you free profits" (which is useful), much like "nobody goes there" and "its too crowded" (hence lots of people do go there). I don't disagree with the assertion that as a trading signal it is useless, there is much better information around where the market is going right now, or perhaps in the short term future. But as an investing signal it serves the purpose well, with fewer stocks than the S&P 500. My parents for example received an inheritance and wanted to invest it, so I suggested an S&P 500 ETF fund. Doesn't cost anything for them to sit on it and when they hear the radio say "The S&P is up 10% for the year so far" they know that their investments are also up about 10% for the year. For a while I had a DOW basket, actually holding shares in the 30 companies in the index. When the DOW hit an all time high I knew my basket of stocks was worth more (as a group) than they had been in the past. Changes in the index did not cause my parents to make trades, instead they just reflected changes in value of that portion of our investment portfolio. And for that it continues to be useful.

dkrich 10y ago

I see a couple of problems with these arguments. First, the assumption that market capitalization is more important for weighting a market index than share price. I'd argue that if your goal is to measure the health of the overall stock market, companies that control the most money should be weighted not much more than less valuable companies. Just because Wal-Mart, Amazon, and Costco are doing great, doesn't mean that JCPenny, Macy's and smaller retailers that employ hundreds of thousands of people are doing great. Giving more weight to smaller companies introduces more companies than just those at the top of the value spectrum. A company with massive resources can probably weather certain negative economic variations better than smaller companies, so to focus solely on those to the exclusion of all others seems to be willfully ignoring a significant part of what comprises the overall market. The other issue is that even though the S&P is cited as being a much better index to track the market, the fact is that the Dow and the S&P correlate almost identically historically. So even if the Dow is reasoned to be much worse than the S&P, history shows that they both reflect basically the same thing.

eb0la 10y ago

Not so useless: you can construct hadge fund-like trading strategies with the DOW and SP500. Both DOW and SP500 have some tendency to go up and down at the same time in bull and bear market times. When this happens you can (for instance) short DOW and long SP500 and your losses in the sort side will be covered by the gains in the logn side... ...but they will be uncorrelated for short periods of time. So, if your short possition goes down while your long is constant or goes down much slower than your short, then you're making money. Probably you can make this kind of hedging with very little money (or almost free) using the fee you get from going short to buy the long leg of the spread.

tempestn 10y ago
So all you need to do is predict the future to know which way to go long/short, and... profit!

rdlecler1 10y ago

S&P 500 and the Dow are highly correlated (95% over the past 50 years) and so as an overall temperature of the market it's typically sufficient.