I wonder if you've ever thought of trading on the American market. It's easier to do than you may think, now that we have financial tools like the contracts for difference and spread betting. In fact you can trade short as easily as long on the major American stocks with a simple spread betting account. But if you're going to go into the American market, you need to understand how it is made up.
The Dow Jones Industrial Average has been around for more than 100 years. It was created by Charles Dow who started a financial newsletter for the folks at Wall Street at the end of the 19th century. The newsletter became the Wall Street Journal.
Charles Dow was very interested in the overall economic climate, so he started tracking an index of several companies shares. The composition of the index does not change much, and even now it only includes the shares of 30 companies, which are appropriately weighted to represent a cross-section of industry.
When it was first created, the Dow Jones Average included transportation stocks, mainly for the railroads. It wasn't very many years before Dow realized he could get a better representation of the health of the economy if he split the stocks, and created an Industrial Average and a Transportation Average. This led to one of the principles of the Dow theory, which is that the transportation and industrial averages should move in concert to indicate a genuine trend, and any divergence suggests that the move is not sustainable. As Dow put it, "What one makes, the other takes".
The only company that has been on the DJIA since its inception is General Electric (GE). It is actually quite astonishing that the health of the entire United States economy is realistically reflected by the DJIA, despite it only being comprised of 30 companies. For instance, the smallest FTSE index has 100 shares. But rather than just taking the largest capitalization, as is done with many indices, the companies on the Dow Jones Industrial Average are chosen with care by the editorial team of the Wall Street Journal, and only rarely replaced. If it's decided to replace a technology company, then another technology company is adopted, maintaining the balance between the sectors.
With that much care in selection, you can be sure that the companies chosen are truly representative of the sectors they are in. The editors are not constrained to the largest capitalization, even though the components of the index do tend to be the biggest corporations. For instance, Microsoft, IBM, Hewlett-Packard, and Intel are in the index representing the technology sector.
This makes stock selection for your spread betting somewhat easier. Your initial sieve can be based on the sector strength, knowing that the companies in the index provide a good representation of the sector as a whole. Only then do you need to look at the individual company details in order to decide whether to include it in your trading plan.
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