August 9, 2011

Dow Jones Averages and their Use

I have spent the last several weeks studying Charles Dow, the Dow Jones Company, and the creation, calculation, and importance of the various Averages created. The three Averages in particular that I have been focusing on in my research, are the Dow Jones Industrial Average, Dow Jones Transportation Average, and the Dow Jones Utility Average. These are indices that investors follow to gauge market direction and performance. Charles Dow, who is one of the co-founders of the company and the driving force behind the creation of the Dow Jones Averages, was a brilliant technical analyst who realized that it was possible to track the general stock market if done in an intelligent, systematic manner

Before the Dow Jones Industrial Average was introduced to the world in 1896, investors did not really have a definitive method for measuring the stock market's general performance. For example, if an investors portfolio went up 7% in a year, it was hard to determine whether that was a decent, great, or exceptional return. With the absence of a benchmark to measure performance against, investors found it difficult to compare their performance to the stock market in general. What Charles Dow and the Dow Jones Company gave to the world, was a new way to interpret the movements of the market, and provide an orderly way to measure investment returns. Before the creation of the Dow Jones Averages, there had not been a clear and systematic approach for identifying and measuring the movements of the stock market and determining its general direction.

Investors and the Dow Benchmarks

The creation of the Dow Averages, allowed investors to compare their own investing performance, to the performance of the index they were tracking. If the Dow Jones Industrial Average was up 10% in a year, and an investor's portfolio was up 15% in the same time frame, the investor could now assess their performance based on how the broader market did (as measured by the Average). Charles told investors that they could identify the longer term direction of the Stock Market by analyzing a chart of the Dow Jones Industrial Average, the Dow Rail Average (now called the Dow Jones Transportation Average) and observing the market's volume (how many shares traded hands in a single trading day) to get a sense of the underlying strength behind an existing trend.

Although this seems like elementary now to many investors, it was revolutionary in The early days of the Dow Averages. They are still used to this day for the same purpose they were initially created for, to gauge and measure the general performance of the stock markets. To see a list of companies that belong to each one of the Dow Jones Averages, follow the links above. They will take you to the Investing for Beginners website where I dedicated a section of my website to providing more detail about the Dow Averages mentioned in this blog post. You will also find self updating charts and stock quotes for each company.

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