Why is the DJIA so popular among traders?

The Dow Jones Industrial Average is one of the oldest stock indices. Critics often accuse it of having a small number of titles, subjective evaluation in the selection of titles, or the construction and calculation method, but it is nevertheless one of the most popular instruments among traders. What is so interesting about it?

The Dow Jones Industrial Average is probably the best known stock index. It tracks the performance of 30 publicly traded companies in the US that are among the most important in their respective industries. Despite its many shortcomings, it is still one of the most followed indices today and is very popular among investors and traders.

The DJIA stock index was created on May 26, 1896 because its founders, Charles Henry Dow and Edward Davis Jones, considered the stock market to be the ideal barometer of the economy. Industry and railroads were the most influential factors in the economy, giving rise to the two oldest stock market indices, now called the Dow Jones Transportation Average and the Dow Jones Industrial Average.

The fact that the DJIA is still one of the most popular instruments among investors and traders today can be attributed to the fact that US equities have performed exceptionally well over the long term and the major indices are at long-term highs, despite the summer sell-off. This year, the DJIA index has already surpassed its all-time high 24 times, and in May it broke through the 40,000-point level for the first time in history (and in July 2024 it has already surpassed the 41,000-point mark).

Interesting fact:
The DJIA is thought to be the oldest stock index, but that's not true. As early as July 3, 1884, the stock average first appeared on the Customers' Afternoon Letter website, tracking the price performance of 11 stock titles, 9 of which were railroad companies. This index became the predecessor to the Dow Jones Railroad Average (renamed the Dow Jones Transportation Average in 1970).

Eternal criticism

However, the Dow Jones index itself has long been criticised by many investors and economists. The most frequent criticism is the number of titles in the index, the construction, the way the index is calculated or the decisions made about individual titles in the index. The DJIA index is generally regarded as a tool for bringing together the largest companies traded on US stock exchanges, but the reality is somewhat different. Since its inception, the composition of the index has been decided by people from the Wall Street Journal, but since 2012, the management of the index has been under S&P Dow Jones Indices, which is owned by S&P Global Inc. Thus, decisions on the composition of the index may not be sufficiently objective.

Many investors would like to see titles such as Nvidia, Facebook (Meta), Google (Alphabet) or Tesla in the index, but they will have a hard time being admitted to the index. Their share price may be a constraint to entry, and a second reason may be the relatively rapid growth of their shares, which would distort the value of the index quite significantly.

Another factor may be the fact that it is a relatively concentrated index with a small number of titles. This is another widely criticised drawback, which complicates its sectoral diversity. There are currently six technology titles in the index and inclusion of another company in this sector is therefore unlikely.

Interesting fact:
Although the index has industrials in its name, companies in this sector now represent only 14% of the index's sector allocation. All sectors except transportation and utilities are represented in the DJIA. The largest sectors (as of July 31, 2024) are Financials (23.4%), Healthcare (19%) and IT (18.8%).

Changes are not frequent

Due to the design and to maintain continuity, changes in the index do not occur very often. Since the index was created in 1896, there have been only 58 changes to the index composition. So far, the most recent company to be added to the DJIA is Amazon. It became part of the index on February 26, 2024, when it replaced Walgreens Boots Alliance.

Interesting fact:
Walgreens Boots Alliance, by the way, replaced General Electric on June 26, 2018, which was the last company to be part of the original index and after two brief "breaks" had been part of the index continuously since 1907. The shortest duration company to be part of the DJIA index was Raytheon Technologies, which lasted less than 5 months (from April 6, 2020 to August 31, 2020).

The index saw the greatest number of changes in its first year of existence, when the index base changed four times in seven months. The other extreme is the period between 1939 and 1976, when the index also changed four times. The longest period without a change in the composition of the index was the interval between March 14, 1939 and July 3, 1956.

Impact of share price

A major criticism is that, unlike most modern indices, it is a price-weighted index. This means that the value of the index and the weighting of individual titles in the index is not influenced by the size of the company or its impact on the economy, but by the share price.

Along with the weight of the index, there is also the issue of how the index is calculated. At the time of its creation, it was a classical average, the value of which was obtained by adding the share price of individual titles and then dividing it by the number of titles in the index, but this is no longer the case today. Already at the time when the index was expanded to 30 titles (1 October 1928), a divisor was introduced (the sum of the share prices is not divided by the number of shares, but by the divisor), which limits the effect of splits, share exchanges, new issues or changes in the index base.

The initial value of the divisor was set at 16.67, but the divisor was gradually reduced following changes or stock splits. Since 1986, the divisor has been less than 1, and after the last change in the composition of the index, its value was set at 0.15265312230608.

Interesting fact:
The fact that the divisor is less than one results in the sum of the stock prices being less than the index value. A movement of one share price of one dollar then means a movement in the index of 6.55 points (1:0.15265312230608) and at the time the official index value was 20,000 points, the real value without the divisor would have been 2,920.43 points.

Imperfect, but still valid and popular

Despite all the criticism and imperfections of the DJIA, the index is still very popular among investors and traders. It's not just that the stock market is doing exceptionally well today. Despite its concentration, the DJIA still retains a kind of aura of something special. The titles it represents are considered leaders in their field, so investors are investing in the exclusive company of companies with a long history of consistently stable earnings and an exceptional position in the stock market.

Many investors also benefit from the fact that it is not an overly broad portfolio, which can sometimes be a detriment. Even Warren Buffett, the famous investor, once said that anyone who buys a few of each stock has not a portfolio, but a zoo. Having 30 strong titles in one index that may be less susceptible to market fluctuations in the event of crises or bear markets in short can sometimes be an advantage.

The DJIA index can be invested in through several different types of products, from funds and ETFs to futures and CFDs, which are also available to FTMO clients under the US30.cash acronym. It is also an increasingly popular product among them, and among index instruments it is even the most traded instrument, exceeded only by gold overall. Trade safe!

Some interesting facts about the DJIA:

The initial value of the DJIA index on May 26, 1896 was 40.94 points. In the first two months, however, the index fell to its all-time low of 28.48 points, which was recorded on August 8, 1896.

The index reached 100 points for the first time on January 12, 1906, when it closed at 100.25 points.

No data are available for the DJIA for the period between July 30 and December 12, 1914, as trading on the New York Stock Exchange was suspended due to fears of a possible market slump due to the outbreak of World War I. Beginning October 4, 1916, an updated index of 20 titles was published in the Wall Street Journal, of which 12 were new and 8 were part of the original line up of 12 titles. For the sake of continuity, the data in the new index was calculated up to the aforementioned date of December 12, 1914. Thus, between December 12, 1914 and October 4, 1916, there are two sets of data for the DJIA index, with the value of the original index with 12 titles being about 36% higher. Thus, many databases have adjusted the original data backwards to maintain continuity.

The index recorded its highest annual percentage gain in 1915, when it appreciated by 81.66%.

In 1931, the index recorded the largest annual percentage loss (52.67%).

The longest period between the maximum closing price before the crisis and the subsequent new record value was more than 25 years. The maximum closing price of September 3, 1929 (381.17 points) was not surpassed until November 23, 1954 (382.74 points).

It took nearly 70 years for the index to surpass 1,000 points, reaching that level in trading on January 18, 1966. However, the close above 1,000 points did not occur until nearly seven more years later, on November 14, 1972. The shortest time it took to cross the millennium was between 32,000 and 33,000 points, when the index needed only 5 trading days to do so (between March 10, 2021 and March 17, 2021).

The index closed at 5,000 points for the first time on 21 November 1995 (5,023.55 points).

The index closed at 10,000 points for the first time on March 29, 1999 (10 006,78 points).

The index closed at 20,000 points for the first time on January 25, 2017 (20 068.51 points).

The index closed at 30,000 points for the first time on November 24, 2020 (30 046,24 points).

The index closed at 40,000 points for the first time on May 17, 2024 (40 003.59 points).