The bad streak of the Dow Jones showed its great weakness: Chart of the week

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With its 0.04% gain on Thursday, the Dow Jones finally snapped its 10-day losing streak, its worst since the 1970s.

This week’s performance was another reminder of why the historically important index is now more historical than important, having long ceded its role to the S&P 500.

Before the dramatic market reaction to the Federal Reserve on Wednesday, the Dow Jones had been going against the S&P 500 and the Nasdaq and was in a historic crisis.

A good part of the why came from a dose of bad luck: While almost all of the Magnificent Seven stocks rose, the Dow’s exposure missed the two biggest winners (Tesla and Alphabet) and instead had Nvidia, who has had a difficult situation. month. (The Dow recently added Nvidia in November, ousting struggling Intel.)

On top of that, the Dow Jones had UnitedHealthcare, which has fallen about 20% this month, posting losses twice as large as the second-worst performer, Chevron.

But this bad luck hides the “real problem,” which was the great advantage of the index for so many decades: its price-weighted indexing. Instead of using the market capitalization system, the index is calculated using trading prices, which are only related to the actual valuation if you take into account the number of shares there are. Great for the pre-internet era when you had to calculate quickly with little information, but now it generates some amazing statistics, as our chart of the week shows.

For example, because it trades at nearly $500 per share, UnitedHealthcare ($452 billion market cap) has the second-largest weight in the Dow at 7%. Microsoft, with a cheaper share price, is in third place, with 6%. But Microsoft is worth almost seven times more.

You can do this with many of these: Paint company Sherwin Williams weighs about 1.5 times as much as Apple and is worth just 2.3% of what the tech giant is worth.

And prices don’t just classify stocks for weighting purposes; they make them move differently. A $10 move is the same no matter which company we’re talking about, although it’s a huge 50% jump for a $20 stock and a much smaller 5% deal for a $200 stock. The index doesn’t care.

The Dow is not the only index that uses this method. Japan’s Nikkei 225 is also price-weighted rather than employing the market capitalization method that uses the total value of the components, weighted by size.

Keeping this in mind is useful when analyzing headlines and statistics about the state of the market because every now and then we get another episode of “Price-Weighted Indexing Gone Wrong.”

The story continues