The Dow Jones Industrial Average (DJIA) is one of the most popular U.S. stock market indices in the world, largely due to its long history extending back to the late-1800s. It is referred to in short as the “Dow”.
The index consists of 30 of the largest U.S. companies across a diverse set of sectors, and is a price-based index. The price of the Dow is calculated by adding up the prices of its 30 components and then dividing by the, ‘Dow Divisor’. The Dow Divisor changes in order to maintain index integrity which is impacted by changes in components, stock splits, spin-offs, and other changes to the stocks which make up the Dow. Throughout history the DJIA has been updated by the addition and subtraction of different companies in an attempt to accurately reflect the current U.S. economy.
It is not as popular to trade as the more broadly-based S&P 500 index, but highly correlated to its price fluctuations. The companies which make up the DJIA trade on the New York Stock Exchange (NYSE) and NASDAQ.
How to trade the DJIA
The Dow futures contract is traded on the Chicago Mercantile Exchange (CME). The large contract’s exchange code is “DD”. The value of the contract is calculated by multiplying $25 times the current value of the DJIA. The performance bond, or margin is set at a fraction of the index’s full value and determined by the exchange.
The smaller versions are called an “e-mini”, which have index multipliers of $10 and $5, of which the smallest $5 is the most popular of all three contracts. The $5 Dow trades under the exchange code, “YM”. This is a very popular contract due to its accessibility to the small trader and flexibility for position size. The Dow contract has good liquidity (not as liquid as the S&P 500 futures) and trades nearly 24-hours a day, 5-days a week. Both long and short positions can be established.
There are four expiration months just as there is with the S&P 500 – March, June, September, and December.
Exchange Traded Fund (ETF)
The SPDR Dow Jones Industrial Average ETF trades under the ticker symbol – DIA – and is a very popular way for market participants to trade the Dow. The DIA ETF is also referred to as, “Diamonds”. It is designed to correspond to the price movements of the index.
The DIA ETF trades on the NYSE ARCA Exchange during normal stock exchange hours from 9:30 am – 4:00 pm EST, as well as extended pre and post-market exchange hours. It has very good liquidity.
The DIA requires less capital than futures, but cannot be traded around the clock, so the trader is exposed to gap risk. It is accessible to most individuals without having to be pre-qualified to trade futures or options. Like futures, traders can take advantage of price fluctuations in both directions by buying or shorting.
These are funds which have portfolios that mimic the price fluctuations of the Dow, however, not nearly as many are in existence or as popular as the S&P 500. Index funds have low turn-over and thus charge lower fees than other types of funds. They are meant for the long-term investor, and not used as an active trading vehicle. Generally, these funds come in long-only form.
Options are available for both futures and the ETF. It is highly recommended that one familiarize themselves with how options work before trading them. This is one of the least capital intensive ways to trade the Dow, as options premiums can be as low as a few dollars per contract. Traders can use options as a hedge or to speculate on the direction of the index, both up and down.
Contract for Difference (CFD)
This instrument was designed with the small trader or investor in mind. CFDs are constructed with futures contracts, but made into smaller contracts which require significantly less margin than futures contracts. Just like futures, these trade nearly 24-hours a day, 5-days a week. Most traders in the world outside of the United States have access to a broker who offers CFDs. These can be traded in both directions, long and short.
What impacts the Dow Jones Industrials Average?
Macro-economic conditions weigh significantly on this index as it is reflective of the broader US economy. The direction of the US economy and the Federal Reserve’s position on monetary policy have a large impact on the index.
While the DJIA is not as broad-based as the S&P 500, it is highly correlated and considered to be a forward-looking mechanism for the economy. Often times market participants will sell stocks in anticipation of a weakening economy before it arrives, driving down the Dow prior to a slowdown or recession. Conversely, before a slowdown or recession ends, the Dow will often times recover significantly beforehand.
The Dow is made up made up of 30 stocks, making each component important. Unlike the more broadly-based S&P 500, the Dow has only 30 components. If any of the components have a significant price fluctuation it can have a material impact on the overall index. The top 10 constituents combined make up roughly 50% of the index.
Company earnings are reported on a quarterly basis each year. The majority of these companies report results in the month following the end of its latest fiscal quarter – April, July, October, and January.