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Source: Getty

History of the Dow Jones as an Economic Gauge

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The Dow Jones Industrial Average, also called the Dow Jones or simply the Dow, is one of the most-used gauges of the stock market performance and the economy. The other stock market and economic barometers are the S&P 500 Index and Nasdaq Composite Index. 

The Dow Jones Index tracks the performance of 30 large US-listed companies that have a significant impact on the economy. CNBC has a current list of Dow component companies. The S&P Dow Jones Indices maintains the Dow Jones Index. 

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The composition of Dow companies has changed dozens of times since the index started. The changes in Dow components results from companies being removed or added to the index. A committee is responsible for selecting Dow component companies. The famous companies that have lost their spots in the Dow Jones Index include General Electric, Citigroup, Sears, and Bethlehem Steel. 

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Investors use the Dow Jones Index to try to decipher the economy's health. The economy is deemed strong when the Dow is rising and weak when the Dow is falling. The Dow recorded a series of declines in March this year due to the coronavirus outbreak, which created a headwind to economic growth. 

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Calculating the Dow Jones Index's value

The Dow Jones Index's value is calculated by dividing the sum of the stock price of its component companies by a factor called the Dow Divisor. The Dow Divisor changes whenever a component company splits its stock or pays dividends.

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The Dow Jones was created by Charles Dow. It was named after Dow and his business partner Edward Jones. The Dow's value was first calculated in 1896. 

The Dow launched with 12 companies. The original Dow components were railroads, sugar, cotton, tobacco, and oil and gas companies. Before the current use of a constant factor called the Dow Divisor, the Dow's value was simply the average of component companies' stock prices. The Dow’s first published value was $40.94. The value was adopted in calculating the Dow Jones Index's value. The average price of the index’s original stocks was $40.94.

Dow Jones Index's drawbacks as an economic indicator

Although the Dow Jones is widely used to gauge economic conditions, some investors think that it is limited for this purpose. The common argument is that the Dow does not reflect the status of the economy since it only consists of 30 companies. These critics view the S&P 500 as a better representation of the economy. The S&P 500 is comprised of 500 companies. 

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The other argument against the Dow Jones as an economic barometer is that it only focuses on the component companies’ stock price while discounting their size. The S&P 500 takes into account size in terms of market cap as well as the stock price. 

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Source: Getty

Dow Jones Index's all-time high value

The Dow Jones Index's all-time high value of 29,551 was set in February 2020. The index closed at 27,891.44 on Monday. The Dow's value shifts with changes in component companies' stock prices.

The Dow Jones is down more than 2.6 percent this year. In contrast, the S&P 500 Index is up 4 percent, while the Nasdaq Composite has gained more than 22 percent this year.

Finally, you can invest in the Dow Jones by buying ETFs. Online brokerage firm Robinhood allows you to buy and sell ETFs and other securities for free. 

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