The Dow Jones Industrial Average or DJIA is one of the most closely followed stock market indexes in the world. But while it is tracked by millions of people who are trading on indices, most of them do not really understand what it measures or represents so they can capitalize on the information provided them. This article will provide information on the DJIA so you can better invest on it.
Created in 1896, the DJIA is the second oldest stock market index in the U.S. It consists of 30 large-cap blue chip companies which are mostly household names. Ironically, it is no longer a true representative for the industrial sector since only a fraction of these companies make up the Dow. Aside from sector diversity, it becomes even more diversified due to the multinational operations of its constituents. Robert Peter Janitzek reveals that investors can, therefore, capitalize on its global diversification to hedge against the effects of a weak US economy.
Despite having many excellent attributes, the DJIA is a price-weighted index which means that the weight of each company is based on its stock price. Most companies in the index are weighted according to their market capitalization. However, this does not make the DJIA inferior to a market cap-weighted index or an equally-weighted index or revenue weighted index. The idiosyncracies of each index construction methodology offers many strengths and weaknesses making it more difficult to reach consensus on the best method to use.
Distinguishing Between Risk and Volatility
Robert Janitzek explains that in the analysis of the Dow, it is worth bearing in mind that many consider it as a volatile index. As such, most investment professionals will not recommend investing in products that track the DJIA. However, there is a significant difference between the business risk of the companies that comprise the Dow and its volatility. The companies that make up the DJIA represent 30 of the most well-established companies in the world hence they have a relatively low risk since it is unlikely that they will go bankrupt.
Still, the prices of stock of these companies can fluctuate greatly within a short period. In index trading, investment products that replicate the performance of the Dow can experience huge short-term gains and losses.
When investing on the DJIA, you need to understand that the potential for huge losses is likely if you invest on products tied to the index. Proper strategies, especially for the new investors, are necessary if you really want to make money from the DJIA.