Big changes are coming to the Dow Jones Industrial Average.
According to CNBC, Alcoa, Bank of America, and Hewlett-Packard are being dropped from the 30-stock index.
They’ll be replaced by Goldman Sachs, Nike, and Visa
Already, market-watchers are pointing out how future moves in certain industries will have distorted effect on the price-weighted index.
Let’s run through a quick example.
Take the banking sector:
Goldman Sachs is currently priced at $US159.49 per share.
Bank of America is priced at $US14.48.
Because the index is price weighted, a 1% move in the banking sector (assuming Goldman and BofA move hand-in-hand) will have a much larger impact on how the Dow moves.
Currently, a 1 point move in a Dow stock translates to a 7.68 point move in the Dow as a whole (this calculation is likely to be tweaked.)
A 1% move in Bank of America ($0.14) would add 1.1 point to the Dow.
A 1% move in Goldman Sachs ($1.59) would add 12.2 points to the Dow.
Right away you can see why people have gripes about the index, which is supposed to be representative of the U.S. economy.
According to CNBC, the changes become effective on September 23.