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Once you understand the Dow Jones Averages, you can better to use it to your advantage.

What is the Dow Jones Average?  In its simplest form it is a market index composed of 30 large well know U.S. stocks created by Charles Dow.  This index was first calculated on May 26, 1896, which gives it the most history of any index.  The Dow Jones can be called several different names, such as the Industrial Average, Dow Jones Industrial, Dow 30 or just Dow.  It is a price-weighted index which is different than most other indexes created more recently such as the S&P 500 which is capitalization-weighted*.

The price-weighted methodology allocates more to higher priced stock even though it may not be the larger company.  For example, if a stock’s price is $100 it would be weighted ten times more than a stock priced at $10.  On the other hand, capitalization-weighted* uses the size of the company (Market Cap**) to set the percentage of the index.

Components in the Averages are added and deleted on an as needed basis.  Over time the changes in the Dow are relatively rare and usually occur after corporate acquisitions or other changes in the company’s core business.  When a change does happen they take time to review all of the components in the index to make sure nothing else has changed.

In order for a company to qualify for the Dow Jones Average it has to have an excellent reputation, show sustained growth and above average trading volume.  The sector allocation is also a consideration when they are looking to add or remove a company.

Understanding the Terms:
Capitalization-weighted – is a method to calculate and index by weighted the percentage of the stock’s value based on the market cap or total value of outstanding shares.
**Market Cap – is the total value of the outstanding share of a publicly traded company.  The value equals the total number of shares outstanding times the current price.

Current Companies in the Dow Jones Average (as of 03/13/14):

One of the most popular and simple strategies that you can trade is the “Dogs of the Dow”.  This strategy is incredibly simple and has shown to beat the Dow Jones Averages over time.  This simple method selects the top ten yielding stocks from the Dow Jones Average every year and then equally allocates your money in each of them.  Every year you review the top ten yielding stocks and replace the ones that have fallen out of the top ten.  There are variations on this strategy where they used the top 5 or top 4.  Motley Fool has come up with another way to trade this strategy and that is to select the top 4 yielding stocks and allocate 40% to the lowest priced stock and 20% to the other three.  There are a lot of ways to try to refine this trading system but the simplicity is one of the better qualities of this type of system.

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