What Happens When the Dow Jones Average Drops?

by Patrick Gleeson, Ph. D., ; Updated September 26, 2017

The Dow Jones Industrial Average, which stock-market watchers usually call "the Dow Jones" or simply "the Dow," is an index of the combined stock value of 30 large U.S. corporations. This value is recalculated several times each second. A long-term drop in the Dow reflects declining investor confidence and other adverse financial conditions that hurt government, corporations and consumers.

Representative Corporations

The Dow Jones Industrial Average is one of the market's oldest financial tools--more than 100 years old--and over time stock components are replaced to reflect the rising or falling importance of different industries. Current Dow components include 3M, IBM, Wal-Mart and ExxonMobil.

The Dow, Minute-by-Minute

The DJIA gives investors a reliable overview of market conditions, both minute by minute and over longer periods of time. Computerization has made it easy for online and broadcast market institutions to update the composite value of the underlying corporations many times a second, and in the case of online sites, to provide interactive charts showing changes in value over almost any period of time individual investors specify. For the average investor, these moment-by-moment changes are probably less significant than charts of longer Dow trends.

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Cause and Effect

When the DJIA drops significantly over a long period, this both reflects adverse market conditions and to some significant degree, aggravates adverse market conditions by warning investors of declining values that may constitute a long-term trend.

When the Dow Drops

The market meltdown of 2008, for example, began with severe and almost unprecedented drops in the DJIA over a period of days, which led to investor panic—not only among retail investors, but among U.S. investment institutions, some of which then failed.

The Powerful Influence of the Dow

While market analysts acknowledge cycles of boom and bust in all financial markets, the unique power of U.S. financial institutions, exemplified by the 30 large U.S. institutions that make up the Dow, is such that a significant drop in the Dow can (and in 2008 did) initiate a worldwide panic and the most severe recession since the Great Depression of the 1930s.

References

  • Manias, Panics, and Crashes: A History of Financial Crises; Charles Kindleberger et al, 1978
  • The Intelligence Investor: The Definitive Book of Value Investing (revised); Benjamin Graham et al, 1973, 2003 (revised)

About the Author

Patrick Gleeson received a doctorate in 18th century English literature at the University of Washington. He served as a professor of English at the University of Victoria and was head of freshman English at San Francisco State University. Gleeson is the director of technical publications for McClarie Group and manages an investment fund. He is a Registered Investment Advisor.

Photo Credits

  • Stock Market Crash image by Paul Heasman from Fotolia.com
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