How to Spread Bet the Dow

The Dow Jones is a major US index, and is a popular choice for spread betting. “Dow” is short for Dow Jones Industrial Average (DJIA), and it is one of many indices produced by the Dow Jones company, which also publishes the Wall Street Journal. It is based on just 30 major US companies, with their price-weighted to reflect the overall spread of industry and commerce in America. This means that the higher priced companies have a greater impact than lower-priced ones. If you want a more balanced index you could look at the S&P 500 which is about the equivalent of our FTSE All-Share index.

The Dow Jones is a popular index which provides a weighted average of the performance of 30 leading stocks listed on the NYSE [New York Stock Exchange] and Nasdaq. This index is by far the supreme, most closely watched index in the world.

Trading the Dow Jones: Wall Street Index by Alastair McCaig at IG Index

How To Trade The Dow Jones

The Dow Jones is the most recognisable stock market index across the globe; a barometer showing the health of the US economy. But did you know that the index is made up of only 30 US companies, and that its calculation is as simple as Wayne Rooney? The key to trading is to know what you’re trading so check out a few more facts to help you make money on the Dow.

What Is The Dow Jones?

Wall Street Index
The Dow Jones Industrial Average Index, to give it its formal title, is a price-weighted index of 30 of the top companies in America with a total market cap of $3.5 trillion. It is provided, and owned, by Dow Jones & Co, a subsidiary of News Corporation.

The index was created by Charles Dow (he of Dow Theory fame) with the help of Edward Jones (who didn’t go on to set-up a financial brokerage of the same name). They launched their prototype, the Dow Jones Averages, in 1884, and the real deal in 1896. The original index comprised only 12 stocks and had a value of 40. In 1928, just before the crash, the index was expanded to 30 stocks.

Of the original gang of 12, which included the Tennessee Coal, Iron and Railroad Company and Distilling & Cattle Feeding Company, only General Electric has stood the test of time. Over the years the index components have changed to reflect the shift from industry towards technology, finance and consumers.

Looking Under The Bonnet

Back in 1896 Charlie Dow couldn’t get a Calculus app’ on his i-abacus so he calculated the early index with no more than a pen and a fag packet. He simply added up the 12 stock prices and divided the total by 12. Since then the only tinkering has been the introduction of a stock divisor, an adjustment that takes account of mergers, stock splits and stock dividends.

Unlike the quarterly promotion/ relegation battles of our own FTSE, the Dow constituents are reviewed on an ‘as needed’ basis, and get this, selection isn’t based on anything as crude as market capitalisation; it’s left to the judgement of the editors of the Wall Street Journal (also owned by News Corporation).

The index is reviewed at least once a year, but the Americans prefer continuity, and changes are rare and usually only take place after an acquisition or major change of business. There are no set criteria for group membership, but a stock has to have “an excellent reputation, sustained growth, wide investor appeal and accurately represent a sector covered by the index”.

Despite the ‘Industrial’ tag the index was set up to “cover all industries with the exception of utilities and transport”, though little did they know that in 2010, 20% of the index would be technology stocks and 10% money-lenders.

Here are the top 5 categories now:

1. Technology – 20.27%
2. Industrials – 14.91%
3. Oil & Gas – 12.33%
4. Health Care – 11.09%
5. Financials – 10.87%

Who’s In The Dow?

The Dow is the who’s who of corporate America; companies include Walt Disney, oil giant Exxon, AT&T and Boeing. Silicon Valley is well represented by Intel, IBM, Microsoft and HP, and JP Morgan, Bank of America and Amex carry the financial weighting. Oh, and purveyor of US cuisine to the world, McDonald’s complements Coca-Cola. Here’s a full list of the Dow Jones Components.

One thing to bear in mind though is that these are multi-national companies that do business across the globe. So, for example, techie stocks like IBM and Microsoft aren’t reliant purely on the US market, just as Exxon’s fate is more likely in the hands of those running the oil market, whether that’s OPEC or a few guys with guns in the Niger Delta.

Trading The Dow

As with trading the FTSE 100 we don’t actually trade the Dow Jones index itself. You’ve probably noticed the Capital Spreads’ spreadbet is on Wall Street, just to be different.

The Dow Jones index is calculated on live stock prices during the UK hours of 14:30 and 21:00. But the modern multi-techno global financial world craves action 24/7 and it can get this by trading the Dow Jones Future.

With providers like Capital Spreads, the Wall Street index trades around the clock with just two breaks (21:15-21:30 and 22.30-23:00) and is calculated every second. For all intents and purposes, the Wall Street spread bet and Dow Jones Future are identical as they are both based off the underlying 30 companies’ share prices. When the Dow Jones Cash is open for trading, the Future reflects the movement of it. When the Cash and constituent companies are closed, the Future reflects what is happening in the overall market.

There are also quarterly Wall Street contracts to allow traders to run positions for several weeks or months. The quarterly contracts are March, June, September and December and will trade at a different price to the Wall Street Future. It’s important to know that these price differences don’t reflect a view on where the market is likely to be at that time; the difference is a mathematical calculation adjusting upwards for interest rates and downwards for dividends.

A Few Things Worth Knowing Before Trading

  1. Even though this is the high profile ‘benchmark’ for the US, its composition of only 30 stocks means that it’s not really an accurate reflection of the US as a whole. Or to put it another way, if you’re trading the Dow you need to be aware that it can be thrown off kilter more easily by a move in a single stock price and that it doesn’t have the risk-diversification of the S&P 500.
  2. The index is only price weighted, which means that higher-priced companies in the index have a greater percentage impact than the lower priced ones. As such a 1% move in IBM (currently $130) will have a much bigger effect than a 1% move in Intel (currently $23) or GE (currently $18) regardless of market cap. This goes back to the diversification again; your view on US stocks in general could be compromised by some news flow on IBM, which accounts for 9% of the index.
  3. Be careful trading from the open at 14:30pm till around 14:45pm; there might only be 30 stocks but the Dow opens slowly and a move in the index during that period might not be representative of the full index.

DOW is a reasonable index to play for 3 reasons:

  • It is a surprisingly sound all round index.
  • It has enough liquidity that you can trade it 24 hours a day instead of 8.5.
  • The Crash prevention committee can only afford to “fix” its trend for about a week twice a year.

If you watch financial news, you will see that the Dow is fairly volatile, and capable of moving several hundred points in a day. For that reason, when you start spread betting on the DJIA you may want to keep the size of your bets down until you feel confident that you can anticipate its movement most of the time.

Most spread betting providers will give you a small spread when betting on the Dow, but if they give you a variable spread you will find that it is the least while the American markets are open, corresponding to the UK’s afternoon and evening, as the provider is able to hedge your bets as much as they want. The spread will increase when the US markets are closed.

The Dow index is moved by global forces, because of the size of America’s economy, so it is necessary to stay on top of international news for any signs that will impact its value. This might include watching CNBC or CNN on the television if you are day trading. Often a presidential address is the trigger for market moves, as well as announcements by the Federal Reserve Bank on interest rates and spending.

Other items that can be watched include the unemployment report for the United States, the consumer price index, and housing price reports. The market commonly reacts to these, particularly if the news is unexpected or not as hoped. Reportedly, one spreadbetters made a £700,000 gain buying the Dow Jones Industrial Average in November 2010 when Fed charmain Ben Bernanke announced the $600 billion quantitative easing programme. The punter, an IT employee, bought the Dow Jones for £10 a point at 10,900, but increased his bet twice after the trade moved in his favour – before closing out the spreadbet for £1000 a point with Spreadex when the index hit 12,000 in January.

Because of the volatility, some spread betters stay away from bets when these announcements are due, fearing a rapid move that can catch them out. An alternative way to play the news is to watch the market closely as announcements are made, and wait to see in what direction it breaks before placing a bet. The direction is not always predictable, because frequently the market anticipates the news and has already priced it into the index before the announcement. Any deviation from the market’s expectation when the announcements are made can have an impact, so even if the news is good the market can slump if it had expected better and had priced that into the shares that make up the Dow Jones index. Similarly, bad news that had been previously anticipated does not always result in a price downturn.

“Si on indices if you’re cracking the Dow then you should be able to trade anything, sometimes it’s purely a confidence thing you feel that the Dow Jones is where you can win so perhaps psychologically you are trading it differently, a lot of trading is about confidence because going underwater with a trade is going to happen it’s learning how to handle that and when to cut it, really those decisions should have been made before the trade was entered. This coupled with stops should prevent you from getting wiped out while allowing the trade to react to your trade plan. Nothing is worse than getting wiped out on a trade and then it swings back into profit!”

But why is the Dow Jones such an important economic indicator?

This is a bit of a tricky question but in reality it is important because the world considers it important. Sounds confusing? Many years ago the index was the only practical benchmark for the market. However, once the processing powers of computers increased, market-capitalization-weighted indices such as the S&P 500 came into being. These are not only useful barometers of economic activity, but also as benchmarkets for funds. The Wall Street index isn’t good for this because first of all it is price-weighted as opposed to cap-weighted and it only has 30 names in it.

Spread Betting the Dow

One of the most popular indices for spread trading, behind the UK 100, is the Dow Jones Index. Most beginners are attracted to trading the Dow because it is the layman’s index – the high volume, high liquidity, easy-to-trade and globally followed Dow Jones index! Because there are many Dow Jones indices, the more proper name for this is the Dow Jones Industrial Average (DJIA), but your spread betting company will know which you mean.

This index is competitive, which means the spreads are fairly small with most spread betting providers. Spread betting provider IG Index for example may quote you 11,289 – 11,291. What this means is that you can place a bet that the index will go up at a price of 11,291, or one that it will fall at a price of 11,289. You lose or gain the amount you bet for every unit the Dow rises or falls.

“Wall Street” is another reference for Dow, although spread trading firms will offer several different versions. One is the brokers’ cash version. But spread betting providers will also offer various futures contracts – there are four of these each year, the present one being June (the real instrument is YM M2 – YM is the Dow Jones code, M is June, 2 is 2012).

For example you may choose to bet £5 that Wall Street will rise, and this bet will be placed at the price of 11,291. If you bought at this price and the index rose, then the spread betting quote could move to 11,563 – 11,565. You might decide to close your bet while you are in profit, and would sell at 11,563.

You can work out your profit like this –

Amount the index went up equals 11,563-11,291

Therefore increase in index equals 272

Your bet was £5 per point

Your profit is 272 times £5, equals £1360

If instead the Dow fell, to a price of for example 11,083 – 11,085, you could decide to close your bet to restrict your losses. If this happened, you would sell your bet at 11,083, and that would give you a loss of 11,291-11,083, equals 208.

In this case the amount you would lose is 208 times £5, which would be £1040.

If you had the alternative view that Wall Street was going to drop, one of the advantages of spread betting is that you can sell the market as easily as buy it. Taking the same figures as before, you can sell the Dow at 11,289, for say £2 per point.

Say that the Dow fell to 10,962 – 10,964 you might decide to take your profit, closing your bet at 10,964. The amount the index went down is 11,289-10,964, a total of 325 points. In this case, your profit would be 325 times £2, which works out to £650.

Of course if the market had increased instead, you will be facing a loss. Say it went up to 11,362 – 11,364 before you decided that the bet was not working and that you had to limit your losses. You would buy to close the bet at 11,364, which would give you a total point change of 11,364-11,289, which equals 75 points.

As your bet size was £2 per point, in this case you would lose £150. Please note that with spread betting being a leveraged product, you could net losses that exceed your initial deposit.

If you watch the streaming prices that your spread betting provider puts on the website, you will see that Wall Street moves quickly, and sometimes several hundred points. It’s probably because of this volatility that it is so popular with spread betters looking for a quick profit.

“13k itself is fairly arbitrary today, we feel uncomfortable at the level because we’ve been here in the 1990s, and can easily feel like the Dow Jones has “gone nowhere” in over a decade. But considering we had no right to be at these levels in the 1990s (we got to an average P/E of 27 on the large cap S&P500), it’s a mistake to compare those kinds of statistics. In 2011, that same P/E was 12 – meaning our indices would have to more than double to be at the 1999 valuation.”

Trading Strategies For The Dow

People love to trade the index because it is constantly in the news and everyone has heard about it. It is also quite volatile and can move 100 points even in a relatively quiet day.

As with the sister piece to this on trading the FTSE, I’ve stayed away from recommending any trading strategies. It’s a massive topic, and of course what works for one person will fail for another. Traders I’ve met trade either by backing their macro-economic views or else by using the charts.

Anyone who trades the Dow should understand Non-Farm Payrolls and the other top US Economic releases, as these will have such a big impact on the price.

Can I trade other indexes, eg., FTSE 100 index, or S&P 500 instead of the Dow?

Of course! But keep in mind that due to the fact that the Dow is a leading global index, most all other major indexes throughout the world, take their ‘cue’ from the Dow. So, whether you are trading the S&P 500 index, the Nasdaq 100 index, the UK FTSE 100 index, the French CAC, German Dax, the Canadian TSX index, or the Australian All-Ordinaries/S&P Index they will all be influenced to what happens on the other side of the pond!

Note: In practice day trading the Dow Jones using spreadbets is no riskier than any other kind of leveraged trading but due to its big volatile daily range, getting the entry level right is important, and a tight stop loss is probably better. I don’t particularly like trading the Dow due to its volatility particularly when it comes to shorting. The reason I don’t like trading Dow short daily is that it does nothing in a straight line. It’s very difficult/emotional to decide when to take profits. Candles get too volatile and moving averages don’t work with any consistency. Large profits can evaporate with trailing stops or indicator signals. If you tighten stops to avoid giving back too much profit you get chopped in and out which again is too emotional. It’s a zero sum game in which the professionals with their computers seem better than me. It’s a completely different ball game to small company trends which tend to move in fairly straight lines.

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