PHILIP OLSON: What the heck is that Dow?

For many people, the Dow is one of those terms that when you hear it on TV or read it in an article, your eyes glaze over and your mind wanders to something more relevant to your life, like whether you could fit 12 marshmallows in your mouth at once.

But how do you know you don't need to know what the Dow is when you don't know what the Dow is?

[music playing] [change rattling] In the late 19th century, a newspaper editor named Charles Dow and a statistician named Edward Jones wanted to create a simple tool for measuring how the US economy was doing day-to-day.

Since most of the economy was industrial at the time, they decided to combine the stock prices of the 12 biggest industrial companies into one statistic, the Dow Jones Industrial Average.

Those 12 companies were American Cotton Oil Company, American Sugar Company, American Tobacco Company, Chicago Gas Company, Distilling And Cattle Feeding Company, Laclede Gas Company, National Lead Company, North American Company, Tennessee Coal, Iron, and Railroad company, US Leather Company, United States Rubber Company, and the only one still on the Dow today, General Electric.

PHILIP OLSON: Today, 30 companies make up the Dow.

And their share prices are used as an index, or a benchmark, not just for how the stock market is performing in general, but also how specific companies are performing compared to the market.

So for instance, if you own a blue chip stock that's holding steady while the Dow is going down, you can say that your stock is outperforming the market.

But wait a minute, there's almost 4,000 companies being traded on the US stock market.

How can just 30 provide a reliable snapshot, no matter how big they are?

That's a valid question.

Some people think the Dow's importance has been blown way out of proportion.

After all, these 30 companies can be doing well while most Americans are hurting, like in the case of massive layoffs.

And as you've probably noticed, they do a lot of business overseas, so their share prices don't necessarily reflect the strengths of the American economy.

So why do you cable news hosts still endlessly refer to it as if it's the "end all be all" of market measurement?

Dow.

Dow.

Dow.

Dow!

Well, the stock market's a funny thing.

Since it's gains and losses are driven largely by whether people are deciding to buy or sell, what's actually happening in the economy is less important than what people think is happening.

An individual stock broker is trying to guess what all the other stock brokers are going to do.

But all the other stock brokers are thinking the exact same thing.

Each investor needs to watch the Dow simply because he or she knows that every other investor is watching the Dow.

It's the starting point of an endless guessing game that often leads to overreactive bubbles and plunges.

Adam Davidson of the "New York Times" called the Dow an "anxiety amplification device."

So do you need to worry about the Dow?

Should you track it like a hawk, updating your 401(k) with every new story?

Or should you just ignore it?

Neither.

Knowing what the Dow is and isn't will help protect you from the hysteria that can dominate the news in times of worry.

But you should know that it's just one of the many indicators of how things are going in the US economy, like GDP, employment numbers, and Treasury interest rates.

Maybe we should take a cue from the man it's named for.

Charles Dow was observed to rarely look at the index himself.

And the executive director of Dow Jones indexes, John Prestbo, recommended that the average investor should only look at the index around once a quarter or once a month at the very most.

So the next time you hear someone on cable news yelling about the Dow, now that you know what it is, you could probably go back to what you were doing.

And that's our two cents.

Are there other phrases or market jargon that you've heard that you feel confused by?

Let us know in the comments, and we'll impact them in a future episode.

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