Dow Investment Stock Strategies

Traders watch the Dow Jones averages for hints on the direction of the stock market.

There are three original Dow Jones indexes on which most Dow trading strategies are based: the Dow Jones Industrial Average, the DJ Transportation Average and the DJ Utility Average. Signals given by these averages have been followed by traders for decades for hints regarding the future direction of the stock market as a whole. The major investment strategy based on the Dow is called Dogs of the Dow.

Dogs of the Dow

The Dow Jones Industrial Average consists of 30 companies that have excellent reputations, demonstrate sustained growth, are of interest to a large number of investors, and represent the key sectors of the economy. This index is maintained and monitored by the editors of The Wall Street Journal. One of the most successful investing strategies is called the Dogs of the Dow. Buy the 10 highest-yielding stocks of the Dow 30 industrials and, at the end of the year, sell any that have increased in price enough to put them in the low-yielding third of the DJIA. Replace those stocks with the current highest-yielding stocks. This theory is based on the assumption that a company's dividend is a reflection of its profitability. When normal market fluctuations cause the price of certain companies to decline, their dividend yield increases because the dividend amount rarely changes. This theoretically means that those companies with the highest dividend yields are trading at the low points of their trading cycles and are good buys. It also means that savvy stock investors will probably be looking to buy higher-yielding stock and will cause the prices to rise as they buy their positions.

Dow Transports

The DJ Transportation Average is believed by many professional investors to predict the health of the economy. The reasoning behind this is the fact that when manufacturers order raw materials and distribution centers and stores order goods from manufacturers, they are shipped by rail and the profits made by the shippers show up in a rise in the transports. An increase in inventories during a recession is said to indicate that the recession is at an end because manufacturers and stores feel consumer demand is rising. Therefore, Dow watchers buy stock when they see the transports begin an uptrend. If the DJIA follows, the bull market is confirmed.

Dow Utilities

The Dow Jones Utilities Index is composed of 15 stocks representing major electric utility companies. It is thought that the DJ Utilities Index predicts interest rates because when utility stock prices rise, the marketplace is discounting lower interest rates, while a decline in the price of utility stocks means that interest rates are expected to rise. This is because utilities pay dividends, and when the marketplace expects bond rates to decline, investors will buy utilities to lock in high rates of return from dividends, causing their stock prices to rise. Utilities are big borrowers and can borrow at the lowest rates, which affects their profitability. If they are borrowing at lower rates, their profits rise and their stock prices also rise -- another sign of potentially lower general interest rates. Lower rates result from the Federal Reserve easing monetary policy in order to bring the economy out of recession. Dow watchers use the DJU to predict an upswing in the stock market due to a recovering economy.

Dow Theory

"What the Industrials make, the Transports take" is a standard Wall Street sayings. It refers to Dow Theory, one of the oldest trading systems in the U.S. securities market. The theory states that the DJ transportation average must confirm the movement of the industrial average for a market trend to be proved. Therefore, when the DJIA reachs a new high, the Transports need to reach a new high to confirm the the bullish market trend. When both averages experience sharp downturns at around the same time, the analysts predict that the bullish trend is at an end. If the Transports decline, it means that the economy is slowing and the DJIA will likely experience a significant drop.

References

• StockCharts.com: Dow Theory
• Dow Jones Indexes: About the Averages