Without knowledge of the past there is no future

Set of shares

An index is calculated on the basis of a set of share prices. Every index has its own formula and the formula results in the number of points of the index. However, this set of shares changes regularly. For a new period, the value is based on a different set of shares. It seems very strange that these different sets of shares are represented as the same unit. After a period of 25 years, the value of the original set of apples is compared to the value of a set of pears. At the moment only six of the original 30 companies that made up the DJIA at the start of the acceleration of the last revolution (1979) are still present.

Formula

Even more disturbing is the fact that with every change in the set of shares used to calculate the number of points, the formula also changes. This is done because the index, which is the result of two different sets of shares at the moment the set is changed, must be the same for both sets at that point in time. The index graphs must be continuous lines. For example, the DJIA is calculated by adding the share prices and dividing this result by some number. Because of changes in the set of shares and the splitting of shares the denominator changes continuously. At the moment the divider is 0.132319125, but in 1985 this number was higher than 1. An index point in the two different periods of time is therefore calculated in different ways:

Dow 1985 = (x1 + x2 + ........+x30) / 1

Dow 2013 = (x1 + x2 + ........ + x30) / 0.130216081

In the 1990s many shares were split. To make sure the result of the calculation remained the same, both the number of shares and the divider changed. An increase in share value of $1 of the set of shares in 2013 results is 7.7 times more points than in 1985. The fact that in the 1990s many shares were split is probably the cause of the exponential growth of the DJIA. At the moment the Dow is at 14659 points. If we used the 1985 formula it would be at 1908 points.

Constantly changing set

The most remarkable characteristic is of course the constantly changing set of shares. Generally speaking, the companies that are removed from the set are in a stabilisation or degeneration phase. Companies in a takeoff phase or acceleration phase are added to the set. This greatly increases the chance that the index will increase rather than decrease. This is obvious, especially when this is done during the acceleration phase of a transition. From 1980 onward, seven ICT companies (3M, AT&T, Cisco, HP, IBM, Intel, Microsoft), the engines of the latest revolution, were added to the DJIA as were five financial institutions, which always play an important role in every transition.

Pyramid scheme

This is actually a kind of pyramid scheme. All goes well as long as companies are added that are in their takeoff or acceleration phase. At the end of a transition, however, there will be fewer companies in those phases.

Will the share indexes go down any further?