Okay, I just did some adding based on Friday's Wall Street Journal

[xiphias]

Now, please understand, I don't really grok what exactly the Dow Jones Industrial Average is, or why the stock prices of those companies is supposed to be a mark of the health of the economy as a whole.

And I don't get how they generate that number. So all of what I'm doing might be totally missing the point.

But I did some quick adding. I added up the stock prices of the thirty stocks, in cents, that WERE in the Dow Jones before they switched what made up the Dow Jones, and I divided by 30. And I got 10480, which, as I understand it, is pretty close to what the stock market was.

Then I added up the stock prices of the thirty stocks that are NOW in the Dow Jones and divided by 30. And I got 12185.

Now, like I said, I don't really get how the Dow Jones is calculated. But I thought that maybe if you replaced the lower-priced stocks with the higher-priced stocks, then you'd expect the Dow Jones to go up by 1705, even if stock prices didn't change at all.

But instead, stock prices went up by 150.

Can someone explain to me what that means? Because to me, it looks like stock prices DROPPED by 1555. But that's not what any of the financial news is saying. And I figure that they probably know what's going on better than I do.

At least, I hope they do. But I'm no longer 100% sure about that.

What am I missing?

Comments

[navrins]

One factor I'm pretty sure comes into play is that when stock splits happen, the weighting of the stock in the average changes so that the average doesn't drop a lot because one stock's price dropped by 75% (because each share turned into 4), for instance.

They probably also do some kind of numerical magic when they change what stocks are in the average so that it doesn't magically change the number because a low-priced stock was replaced with a high one (which you'd expect - stocks drop from the average because they're doing too badly to count anymore).

But really, I'm only answering because answering is fun. I don't actually know what I'm talking about.

[mrmorse.livejournal.com]

The Dow is a weighted average. Basically, the price of each stock is multiplied by a number reflecting the total number of shares of that stock and those numbers are summed to get the Dow. This means that the Dow reflects the value of each company rather than the value of each stock.

If one company has issued 100 shares of stock which sell for $10 each, then the value of that company is $1000. If another has issued 200 shares which sell for $10 each, then the value of the second company is $2000. The second company is worth twice as much even though the share prices are the same.

When stocks are added and removed from the Dow, the multipliers are recalibrated so that the Dow should be unchanged after the new company is added. If a smaller company is dropped and a larger company is added, the multipliers for all of the stocks are reduced so the Dow stays constant.

The Dow tends to go up immediately after new stocks are added. This is because many investment funds are based on the Dow. When stocks are added to the Dow, these funds all try to buy the new stock at the same time. This buying pressure pushes the price of the new stock up.

[(Anonymous)]

The stocks in the DJIA are not averaged together. Instead the DJIA is supposed to be equivalent to a basket of stocks (i.e. xx shares of IBM, yy shared of Microsoft, etc.). So when new stocks are added to the Dow, the old stocks in the basket are "sold" and the new stocks in the basket are "bought" with the proceeds so the value of the Dow doesn't change. I don't know how they decide to split up the proceeds, etc. I'm not sure if there is a one-to-one correspondence between new and old stocks (so the new stock is bought entirely with the proceeds of an old one) or if the proceeds are just split evenly and/or whether there is periodic rebalancing among the stocks in the Dow.

[zachkessin.livejournal.com]

Try checking with the Wall St Journal. As Dow Jones is the company that runs the journal and the DJIA is their thing. Its the editors of the Journal that pick which stocks are in it. I would imagine if you look around their site you will find an explination of how they figure it out. Personally I tend it look at the SP500 which is a much broader index (500 stocks vs the 30 for the DJIA) but thats just me.