Why the Dow Jones industrials matter

Why the Dow Jones industrials matter

	Published : Tue, 30 Jan 2007 21:54 By : Agencies Print this Story

(AFX) - Q. Why does Wall Street track the Dow Jones industrial average so closely when it is only made up of 30 stocks? Why not a bigger index?

A. Wall Street Journal founder Charles Dow compiled the index in 1896 as a way to monitor the performance of the industrial component of America's stock markets. The Dow, which is the oldest continuing U.S. market index, originally comprised 12 components that included long-defunct companies like U.S. Leather Co. and Tennessee Coal, Iron and Railroad Co. The only original component still around is General Electric Co.

These days, the index has been broadened to reflect the U.S. economy's move away from big industrial companies. Staples of the modern Dow include big financial companies like Citigroup Inc., technology bellwether IBM Corp., and drug manufacturer Pfizer Inc. The Walt Disney Co. is also a component.

The Dow, which launched at about 40 points and in January surpassed the 12,600 level for the first time, has not been without criticism. The index is a price-weighted average, which gives higher-priced stocks more influence than lower-priced counterparts. And, indeed, some on Wall Street discount the average because it isn't as broad as counterparts like the Standard & Poor's 500 index.

But, analysts believe it is still a useful tool when combined with several other market indicators. Most people on Wall Street use the Dow while also weighing the S&P 500 and the Nasdaq composite. In 2006, these indexes -- though weighted differently and whose components vary in size and scope -- all finished 2006 with or nearly with double-digit gains.

'All the indexes have one flaw or another, but I find the Dow very helpful in providing an overarching view of future market direction,' said Jeff Hirsch, publisher of the Stock Trader's Almanac. 'To get an idea of where things are going, analysts -- technical or otherwise -- have always looked at a small basket of highly influential and sensitive stocks.'

He said using the three major indexes, investors can get a glimpse of performance in the whole market -- America's biggest companies with the Dow, technology stocks with the Nasdaq, and a broader view of the 500 biggest U.S. companies with the S&P.

'With the three combined you get a very good feel for where the market is at and where it's going,' he said.