Dow Jones Trading Strategy — What Is It?

Last Updated on August 26, 2022

The Dow Jones index is as old as the stock market. Investors have been using the index as a market indicator for buying and selling stocks on the US stock markets.

The Dow Jones Index, or Dow 30, is a price-weighted stock index that tracks the performance of 30 prominent blue-chip U.S. stocks listed on the New York Stock Exchange (NYSE) and NASDAQ. It was created by Charles Dow in 1896 to serve as a proxy for the broader U.S. economy. At the end of the article, we present a Dow Jones trading strategy.

Let’s take a look at the index.

What is the Dow Jones index?

The Dow Jones Index or Dow 30 is a stock index that trails the performance of 30 large blue-chip stocks in the United States that are listed on the New York Stock Exchange (NYSE) and NASDAQ. It was created in 1896 by Charles Dow and his partner Edward Jones — the name of the index was coined from the creators’ last names.

It is a price-weighted index and is a widely-watched benchmark index in the U.S. for blue-chip stocks. The index was created to serve as a lens to view the state of the economy of the United States. It is one of the most monitored indexes in the world. All the components of the index are all blue-chip companies that have been proven to have consistent earnings over time.

In the early 20^th century, the Dow was used to gauge the overall growth of the economy, as the Dow’s performance and the overall economy were positively correlated. Up until this moment, some investors still use the Dow to track the health of the economy; a strong performance of the index is seen as a growing economy, while a weak performance is seen as a weakness in the economy).

When the index initially launched in 1896, it had only 12 companies, which were primarily in the industrial sector, including railroads, cotton, gas, sugar, tobacco, and oil. However, as the economy changes over time, the composition of the index also changes — it now has companies from financial services, communications, and information technology. Typically, when a company becomes less relevant to current trends of the economy, it may be replaced by a new name that better reflects the shift.

The Dow is a price-weighted index, which means that companies with a higher stock price are given the greatest weight. So, a significant move in the share price of a component company greatly impacts the index.

The 5 largest holdings in the Dow Jones Index

These are the top 5 holdings in the Dow Jones Index (although this might be changed by the time you read it):

• Apple (AAPL). Apple is a tech giant and the most valuable company in the world. The company has a wide range of technology products that include the iPhone series, iPod, Mac, iPad, Apple TV, and Apple Watch. The company also offers professional software such as iOS, iPadOS, macOS, WatchOS, etc. Its business operations span Africa, the Middle East, Europe, Asia, and the Americas. Apple’s product collections Apple has a market cap of $2.537T as of July 28, 2022, making it the most valuable company in the world by market cap.

• Microsoft Corporation (MSFT). Microsoft Corp. is a technology company that designs, licenses, and supports software, devices, services, and solutions across the globe. It offers business management through its productivity and business processes division. Some of its products include Microsoft Teams, Office, SharePoint, and OneDrive, Skype for business, and Office 365 Security and Compliance amongst others. It also licenses cloud-based software like SQL, Azure, GitHub, Windows Servers, etc. Microsoft Corp. has a total valuation of $2.05 trillion by market cap as of July 28, 2022.

• UnitedHealth Group Inc. (UNH). This is a healthcare company with a wide range of product offerings. It offers health insurance to public sector and private sector workers, small businesses, and individuals. The company’s operations are divided into four segments: Optum Health, Insight, and Rx, United Healthcare. UNH’s market cap as of July 28, 2022, is $504.27B.

• Johnson & Johnson (JNJ). The company discovers and develops pharmaceuticals, consumer packaged goods, and medical devices. It is an industry leader and one of the most valuable healthcare companies in the world. As of July 28, 2022, Johnson & Johnson has a total market cap of $458.21B.

• Visa Inc. (V). The company facilitates digital payments across the world. It offers card products, platforms, and value-added services. Visa is one of the most valuable financial services providers, with a total valuation of $445.40 billion as of July 28, 2022.

Dow Jones trading strategy

You can, of course, develop many trading strategies based on Dow Jones. One of the most famous trading strategies is the Dogs of the Dow. We might argue this is more of an investment strategy than a trading strategy, though. Nevertheless, it’s worth mentioning the strategy because it’s a specific Dow Jones strategy.

The Dogs of the Dow is a pretty simple strategy: at year’s end, you buy the 10 stocks (of 30) with the highest dividend yield. You hold the stocks for a year and then you rebalance again. Rinse and repeat. The strategy worked very well for almost a century, but over the last two decades, it has underperformed.

Below is the performance of the Hennessy Total Return Fund (HDOGX) that tracks the Dogs of the Dow stocks (an ETF):

The red line is the S&P 500 and clearly, the Dogs of the Dow has underperformed.

The underperformance might be explained by the fact that most of the stocks that make the Dow Jones Index come from the “old” economy. The index has perhaps lost some of its glory (as of writing) because of that.