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What is the Dow Jones? | AvaTrade Tutorial
Trading Dow Jones
The stock market index known as the Dow Jones Industrial Average, also called DJIA, the Dow Jones Industrial, the Industrial Average, DJI, the Dow Jones, the Dow 30 or simply the Dow was founded by Charles Dow and Eduard Jones in the mid-1880s.
The index is price weighted average of 30 of the most significant stocks that are traded on the NASDAQ and New York Stock Exchange (NYSE). This particular index is the most followed and watched in the world, as its conglomerates include some of the most accomplished companies recognised worldwide. When you hear ‘the markets are up (or down) today’ they typically refer to the Dow – that is how influential this index is. Currently the index is owned by S&P Dow Jones Indices and that is majority owned by S&P Global.
Charles Dow and Eduard Jones formed the Dow Jones Industrial Average to serve as a proxy for the US economy. From its inception, the DJIA included only 12 companies that were all industrial based. They included gas, cotton, tobacco, oil, sugar that all operated in or with the railroads. General Electric is the one component that is still part of the index today.
The index cultivated more components, from 12 to 30 in 1928 and since has changed these components over 51 times within that time, with the first change that was brought about 3 months after it was first launched in May 1896.
Starting off, the level stood at 62.76 and reached its peak in 1890 to 78.38, then during the summer of 1896 hit an all-time low of 28.48, which later lead to what is known as the ‘panic of 1896’. From 1900s, the momentum picked up and fell over 14 years, and eventually stabilised. However, during the great depression of 1928, the world’s economy had suffered a crash and the index did not recover till 1954, and started to follow market trends as we know today.
Dow Jones Index composition
As the economy experiences changes so does the Dow and its composites. As all its components are price weighted, which means that the price per share for each stock included is divided by the total number of stocks that make up the index.
The corporations of the DJIA are chosen by a committee at Dow Jones S&P Index. The organisation ensures that a healthy and positive reflection of the US economy is at the forefront of the index, and this is the basis for them selecting only the top performing companies. Based on the changes within the corporations which influence will have an effect on the companies that make up the DJIA 30.
|Companies||Index weighting (%)|
|United Health Group||5.47%|
Factors that influence the overall index price
Some of the factors that drive the DJIA include natural calamities, economic slumps within the US or other countries increased oil trading prices. Mostly the index drops due to market uncertainties. Investors usually are cautious when investing in the highly volatile components of the index.
Shares may fall when the Dow sees current investors selling their stocks due to market limitations, which can include a decrease in one or more of the company’s profits or when they are caught in any wrongdoing.
War and terrorism prompt investors to pull out the markets as well as these force a decrease in the demand for goods and services that could be purchased by consumers from the companies that make up the DJIA, thus impacting their revenues.
On the other hand, when investors see a small drop in the Dow this may trigger them to hold onto their shares, and even get them to buy more in the anticipation of the index seeing an increase and the investor enjoying the profits of the market change. When a significant drop in the markets occurs, this could imply the beginning of an economic crisis and will result in a decrease in the stocks value.
DJIA Trading information
- The Dow 30 futures contract is tradable from 22:01 – 20:14 (GMT), Monday to Friday
- The Dow 30 moves in increments of 1.00
- The margin requirement for trading the Dow 30 is usually about 0.5% (i.e. leverage) with most forex broker
- The minimum trade size is 1 index
- The currency of the Dow 30 is the US Dollar
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The Dow Industrials Today
It’s somewhat ironic that the equity index that was created to be a proxy for the industrial sector of America no longer truly serves that function. Today only a small portion of the 30 companies in the DJIA are actually classified as industrial companies. Many are in the consumer or technology sectors. And the only sector unrepresented in the index is the utilities sector.
Here is an alphabetical list (and trading symbol) of the 30 companies in the DJIA as of October 2020:
- 3M (MMM)
- American Express (AXP)
- Amgen (AMGN)
- Apple Inc. (AAPL)
- Boeing (BA)
- Caterpillar (CAT)
- Chevron (CVX)
- Cisco Systems (CSCO)
- The Coca-Cola Company (KO)
- Dow Inc. (DOW)
- Goldman Sachs (GS)
- The Home Depot (HD)
- Honeywell (HON)
- IBM (IBM)
- Intel (INTC)
- Johnson & Johnson (JNJ)
- JPMorgan Chase (JPM)
- McDonald’s (MCD)
- Merck & Co. (MRK)
- Microsoft (MSFT)
- NIKE (NKE)
- Proctor & Gamble (PG)
- Salesforce (CRM)
- The Travelers Companies (TRV)
- UnitedHealth Group (UNH)
- Verizon (VZ)
- Visa (V)
- Walmart (WMT)
- Walgreens Boots Alliance (WBA)
- The Walt Disney Company (DIS)
Besides being very diverse on a sector basis the index gains additional diversification from the multi-national characteristics of its components. This actually allows for a small measure of indirect international exposure, and acts as a hedge against any weakness in the US economy. In addition, all of the DJIA component companies generate substantial revenues, helping to reduce any potential business risks.
Criticism of the Dow Jones Industrial Average
There are many positive attributes of the DJIA, but there have also been criticisms of the index, the chief of which is that it is a price-weighted index. That means the companies weighting in the index is based on its price. By contrast most indices use a market capitalization weighting. The S&P 500 is a good example of one of these indices, and it is one of the things that makes the DJIA and the S&P 500 such different indices.
If the DJIA were to switch to a market capitalization weighting there would be a significant difference in the way the component companies would be weighted in the index. That said, there’s really nothing that makes market capitalization weighting superior to price weighting or even to other weighting methods such as revenue weighting or an equally weighted index. Each index construction method comes with strengths and weaknesses, making it impossible to definitively say one method is superior to another.
The Distinction between Volatility and Risk
When looking at the performance of the DJIA you have to remember that the index is actually considered to be volatile. This discourages some from investing in the DJIA, but for active traders this volatility makes for a perfect index to trade. And it is notable that there is very little business risk in the DJIA because of the strength of its component companies. They are 30 of the most established global brands. There is very little risk of any of them going bankrupt or closing down.
Even so, the price of these companies can vary greatly from day to day and week to week. As a result, the DJIA can also see large daily and weekly moves.
Dow Jones Trading Main FAQs
- What is the Dow Jones 30 Index?
The Dow Jones 30 is a U.S. stock index composed of 30 of the largest publically traded U.S. companies. It was created in 1896 and was meant to be an easy way to track the U.S. stock market performance at a time when information flow was not as rapid or pervasive. The components of the Dow Jones 30 can and do change as companies grow and shrink. The Dow 30 is still considered to be an accurate gauge of the health of the U.S. equity markets.
- Should I trade the Dow Jones 30 Index?
Because of its composition the Dow Jones 30 can be an excellent way to speculate on the strength of the U.S. economy. It is also a good way to speculate on the overall global economy since the Dow 30 components are all multi-national corporations with business spanning the entire globe. Those looking to trade the Dow Jones 30 should become very familiar with all the underlying components too. Because the Dow 30 is a price-weighted index a large move in any of the components can have a significant effect on the index.
- What is the best strategy for trading the Dow Jones 30 Index?
The best strategy for trading the Dow Jones 30 is the one a trader is familiar and comfortable with. Aside from that there are a number of high probability strategies that can be used. One such is based on closing gaps that appear at the open on the Dow Jones 30 chart. In many cases the index will be higher or lower at the open than it was the previous session at the close. This is known as a gap. A high-probability trade is to look to close that gap with your trade. For example, if the market opens lower than the prior close you would enter a long position with the target being the previous session’s close. The gap needs to be at least 20 points, and it shouldn’t be more than 50 points.
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