The Dow Jones is a Stupid Index

Whether or not you are involved in financial markets, you have probably heard of the Dow Jones Index. Also referred to as Dow Jones Industrial Index, DJIA, or DOW.

This blog isn't meant to dig into the complexities of financial markets but rather bring light, and some amusement, to why the Dow Jones is an arbitrary and archaic metric.

It is easier to understand why this is amusing as long as we are totally clear on what a stock index and the Dow Jones in particular is supposed to do.

A stock index, such as the Dow Jones, is supposed to represent the overall stock market.

Now this is amusing because the Dow Jones simply does not do this. First, the Dow Jones is only comprised of 30 companies. Second, and more importantly, the Dow Jones is a Price-Weighted index.

A price-weighted index sounds more complicated than it is. All it means is the index is based on the actual value of each stock included in the index.

As an example, if I wanted to make a price-weighted index with Bitcoin and Ethereum, I would buy 1 Bitcoin and 1 Ethereum and divide by 2. Now obviously this would not represent the entire crypto market. Mainly because it doesn't even take into account how many of each Bitcoin and Ethereum is in the marketplace.

Now the S&P 500 is another widely used index that doesn't have this issue. The S&P 500 is a market-value-weighted index which does take into account a company's total valuation. So not all hope is lost, but it is quite funny we still use the Dow Jones when we don't have to.

But we can cut the Dow Jones some slack, it is about 140 years old however, that's all the more reason not to use it. 😄

Just a final point on something that is funny about the Dow Jones Index. So when the Dow Jones was first created it could easily be calculated by adding the 30 stock prices together and just dividing by 30. However, companies will sometimes do something called a Stock Split. When this happens a company typically doubles the number of stock shares everyone has but also decreases the stock value in half. This is important because the Dow Jones is adjusted so it is not impacted by stock splits. It is also adjusted for Dividends as well. Now you can imagine there has been many stock splits and dividends over the last 140 years.... So now in 2022, instead of dividing by 30 we divide by 0.152 😆.

I hope you enjoyed this blog post! I had the inspiration of writing this after talking with my friends over in the Hive PIZZA discord #market-chat.

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