Hey there! If you’ve ever listened to news about the stock market, you’ve likely heard the reporter say something like “the Dow was up 200 points today.” But what does that actually mean? What is a point in the stock market anyway? Great question! Points can be confusing, but understanding them is key to making sense of stock market movements.
In this comprehensive guide, we’ll break down exactly what points are, how they work, and why they matter for your investing knowledge. Get ready to become a points pro!
How Stock Prices Are Quoted Using Points
Let’s start with the basics – when you hear that a stock price moved up or down by a certain number of points, that refers to actual dollars. One point equals one dollar. So if a stock drops five points, that means the share price decreased by $5. Simple enough, right?
Now, here’s a common mistake – thinking that points reveal how much a stock’s value changed percentage-wise. Not quite! Points only tell you the raw dollar amount gained or lost, not the percent change. For example:
- Company A trades at $10 per share. The stock drops two points to $8 per share. That’s a 20% decrease.
- Company B trades at $100 per share. The stock also drops two points to $98 per share. But that’s only a 2% decrease.
See the difference? Both stocks lost two points but very different percents. So remember, points themselves don’t indicate how significant the move was percentage-wise. They only give the absolute dollar change.
You’ll typically hear points referenced for short term stock movements – how much the price changed today, this week, this month, etc. Points provide an easy way to quote the dollar value difference. Instead of saying “Company Z’s stock price increased by $2.38 today,” they simply say it was up two points. Much simpler!
The Dow Jones Industrial Average and Index Points
One major way points come into play is with the Dow Jones Industrial Average, or DJIA for short. The Dow tracks 30 large U.S. companies like Apple, Microsoft and Coca-Cola. It’s a benchmark of the overall stock market.
The index itself is quoted in points. When news reports say “the Dow rose 150 points” that means the collective value of the underlying 30 stocks increased by $150 total based on their individual price changes. The point gain or loss represents how much the component stocks’ values changed in dollar terms.
But how can the exact dollar value of 30 giant companies be boiled down to neat and tidy points? Here’s where the Dow divisor comes in. The divisor is a number calculated by S&P Dow Jones Indices that adjusts the index value to account for corporate actions like stock splits.
For example, if a company in the Dow does a 2-for-1 stock split, the share price is cut in half even though the company’s overall value remains the same. The divisor adjusts so that the index level itself doesn’t see a big drop from the split.
The bottom line – the Dow uses points to distill the dollar value changes of its 30 components into a single number that acts as a snapshot of the stock market. When the Dow changes by X points, the underlying stocks gained or lost that total dollar amount based on their individual price movements.
Comparing Point Changes vs. Percentage Changes
By now you’re a points pro! Let’s take a moment to reinforce why raw point changes alone don’t reveal the whole picture. Consider two hypothetical scenarios:
- MegaShop Inc trades at $500 per share. The stock falls 20 points to $480 per share.
- MicroPrice Inc trades at $5 per share. The stock also falls 20 points to $4 per share.
In both cases the point drop was 20. But MegaShop’s decline was only 4% while MicroPrice plunged 80%! See how the same point loss can represent vastly different percent changes?
Whenever you hear about stocks moving X points, remember to consider:
- The actual dollar change (1 point = $1)
- How that dollar change relates to the stock’s overall price (the percent change)
To fully grasp the impact, look at both the absolute point shift and the relative percent shift. Like a 1993 study concluded, “a 10 point fall…means something entirely different for a $500 stock than a $50 stock.” Keep that quote in mind next time you hear stocks are up or down X points!
Other Types of Points in Finance
In the stock market, points refer specifically to dollars per share. But you might hear “points” used in other financial contexts too. Two examples:
Basis points (bps) are commonly used to describe movements in bonds or interest rates. One basis point equals 1/100th of a percent. So if a bond yield rises 25 basis points, that means it increased by 0.25%.
Pips are used in foreign currency exchange trading, also known as forex. A pip measures the smallest price move possible for a currency pair. For most major currencies, this is the fourth decimal place. So for EUR/USD, a price could change from 1.1000 to 1.1001 – that 1 pip movement is a single point.
The key takeaway here is that not all points are created equal! In stocks, points represent dollars. In bonds, basis points represent tiny percent shifts. And in forex, pips track fractional currency changes. Same word, different meanings.
Locating Entry and Exit Points for Trades
Understanding points helps you follow market news. But how can savvy investors use points to actually make profitable trades? One way is locating optimal entry and exit points.
An entry point is the price at which you buy a stock – where you enter into your position. Naturally you want the lowest possible entry point.
The exit point is just the opposite – it’s the price where you sell to close out your trade, ideally at a profit. Finding advantageous exit points lets you lock in gains.
Here are some technical indicators traders use to identify good entry and exit levels:
- Moving averages – Tracks average price over time to spot support and resistance levels. Buying near support and selling near resistance provides favorable points.
- Bollinger Bands – Price channels showing relative highs and lows based on volatility. Can time entry points when bands contract or price touches lower band.
- Stochastic oscillator – Index showing momentum by comparing closing price to price range over time. Crossing above 20 signals potential entry point, while crossing below 80 provides exit signal.
- Relative Strength Index (RSI) – Scale from 1 to 100 gauging overbought (above 70) and oversold (below 30) conditions. RSI below 30 suggests entry point, while above 70 flags exit point.
- MACD – Moving Average Convergence Divergence compares short and long term moving averages to identify trend changes. Crossover of MACD line and signal line hints at entry/exit points.
No indicator is perfect or makes success guaranteed. But combining tools like these with thorough research helps traders objectively identify advantageous entry and exit prices.
Criticisms and Limitations of Points
By now you can see that points provide valuable stock market context. However, some criticisms and limitations do exist.
One issue with the Dow’s points system is that price-weighting can distort things. Stocks with extremely high per share prices carry more influence. For example, a $100 gain in a $300 stock like Boeing sways the index more than a $100 gain in a $30 stock like Walgreens, even though the dollar change is equal.
Corporate actions like acquisitions, spinoffs and distributions can also have unintended effects. In 2004 when Microsoft paid a large special dividend, the Dow saw a massive one-day points drop even though overall market value was unchanged. Critics see inconsistencies like this as flaws in the Dow’s point system.
Another concern is that the 30 Dow components are highly correlated in their price movements. So even though the index covers leading blue chip stocks across various sectors, there tends to be a herd mentality in the trading patterns. This undermines how well the Dow represents the broader market using its points methodology.
Some investors argue that point weighting is outdated and distortive compared to market capitalization weighting like the S&P 500. With cap weighting, components influence the index proportional to their total market value rather than share price. This provides a more stable and balanced representation.
- In the stock market, points represent actual dollar amounts gained or lost, not percents. One point equals $1 per share.
- The Dow Jones Industrial Average index uses points to track the dollar value changes of its 30 component stocks.
- Pay attention to both absolute points and relative percentage changes to fully understand a stock’s price movement.
- Other finance terms like basis points for bonds and pips for forex have different meanings than stock points.
- Technical indicators help traders identify advantageous entry and exit points for trades.
- Valid criticisms of points include price distortion, unintended impacts of corporate actions, and high correlation between components.
I hope this guide gave you a solid understanding of what points are, how they work, and things to consider when you hear about stocks moving points in the news. Let me know if you have any other questions!
Phew, there’s a lot to unpack with points! But now you’ve got this covered. Whether you’re a new investor or a seasoned pro, it’s important to understand exactly how points function and what they mean (and don’t mean!) when discussing stocks or indexes like the Dow.
Bottom line – don’t just focus on points in isolation. Look at the full context including absolute dollar changes and relative percentage shifts. And remember, not all “points” are created equal! Basis points for bonds and pips for forex refer to different units of measurement than stock points.
Armed with this knowledge, you’ll be a points expert. When you hear financial news stories quoting points, you’ll know exactly what they imply and make sense of market movements. Understanding points helps lay the foundation to become a savvy investor.
Now go impress your friends at the bar with your newfound mastery of points! But please drink responsibly – even the best traders make mistakes when reviewing their portfolio after a few too many.