Wall Street needs disruption!

There are two traditions associated with Wall Street that bothers me; since it is supposed to employ some of the best minds around. The first one is the Dow Jones Industrial Average (DJIA) – how it is calculated. The second is how especially the media talks about how many points stock indexes moved.

The Dow i.e. DJIA is a price-weighted average of 30 important stocks traded on the NYSE and NASDAQ, created in 1896. A price-weighted index e.g. the Dow, is one that indexed by the proportion of price per share as opposed to market capitalization-weighted index which is indexed by the proportion of market cap of the companies e.g. S&P 500. The problem with the Dow is that the most valuable company might have a share price of $10 while the least valuable a share price of $100. The movement of the price of the stocks will not really mirror the change in the value of the company, but rather the change in stock price, which by itself is not a measure of value. On the other hand, capitalization-weighted index like S&P 500 accurately reflects the change in the value of the 500 most valuable companies. I really do not get why we still stick with the DJIA since it does not measure anything of real value, except for keeping up with old traditions!

The second one is how many points a stock index moved. The DJIA, S&P 500 and NASDAQ closed at 13992.97, 1517.93 and 3193.87 respectively as of Friday, February 8, 2013. For the day, the indexes moved up by 48.92, 8.54 and 28.74 points respectively. By looking at this, it seems as if the DJIA moved up most while the S&P 500 moved the least. However they moved by 0.35%, 0.57% and 0.91% respectively, which presents a very different picture than movement by points. Even if the person knows the closing value of the index of the previous day, they would still have to calculate in terms of percentage point to make sense of how big the movement of the index was anyway! Thus, this does not make sense either to talk about point movements rather than percentage points. My mentor for the CFA Institute Research ChallengeTim Parker  agrees with me on both accounts.

Don’t you think Wall Street is ripe for disruption then?

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