Last Monday morning, the most widely followed and recognized U.S. index looked different from when it closed the Friday before. The Dow Jones Industrial Average (INDEXDJX:.
The Dow's weighting methodology The Dow is a price-weighted index. That means each of its 30 stocks has a greater or lesser influence on the index depending on its stock price. Other indexes, such as the S&P 500, also use a weighting system, but they base their weighting on market capitalization, not share price.
What this means in practice is that the weight of each stock within the index changes with every move higher or lower during the trading day. For example, back on June 19, International Business Machines Corp. (NYSE:IBM) traded for $203.99 per share and accounted for 10.24% of the index. The following day, IBM traded at $199.54 and accounted for just 10% of the Dow's value. At the time, IBM was the most heavily weighted Dow component, and it had been for some time.
As my colleague Anders Bylund explained on those two days, when IBM would gain or lose 1%, it was adding or subtracting 16 points from the Dow. Meanwhile, The Coca-Cola Company (NYSE:KO)'s 0.5% move on June 19 added just 1.5 points to the Dow, since Coke represented only 2.08% of the index that day. Given the stark contrast between the influence of those two stocks, it's easy to see why some investors don't agree with the way the Dow works.
The new Dow and the future With the removal of Alcoa Inc (NYSE:AA), Bank of America Corp (NYSE:BAC), and Hewlett-Packard Company (NYSE:HPQ), the Dow cut the three most lightly weighted Dow components. Based on their Sept. 20 closing prices -- Alcoa at $8.29, Bank of America at $14.44, and Hewlett-Packard at $21.22 -- they represented around a combined 2% of the Dow's value.