A Simple and Profitable Way to Trade the Dow Jones Index

by caseorganic

Article by Jason Nesbitt

How would you like a stock trading indicator that puts you on the right side of the market over 70% of the time, allows you to trade totally mechanically, and requires only a 1% stoploss? Well now you can, with the dowstomper indicator.

The dowstomper, as its name implies, is designed solely to trade the Dow (either with futures, options, exchange traded funds, spreadbetting or CFDs). But before I go into detail – what is the Dow, and why should you trade it?

The Dow Jones Industrial Average (NYSE: DJI) is the most important index of stocks in the States, comprising as it does the 30 most important companies in the USA. Compiled a long time ago by Charles Dow (hence the name!) the Dow index is a way to assess the performance America’s industrial sector.

Once upon a time, the Dow Jones Index was a simple average of the stocks comprising it, but nowadays the index is ‘scaled’ to give more weight to the more important components (Microsoft, for example, is bigger and more important than Caterpillar). This has lead to some criticism of the Index, as, for example, the gains of a small stock or number of stocks can be offset by the losses of one large stock. It is this ‘inefficiency’, by the way, that makes the http://www.dowstomper.com indicator possible – the insight shown by the developers was truly astounding. Another common criticism is that the Dow comprises only 30 stocks – once again this is actually an advantage when trading with the stomper indicator, as the opportunities for the trade arise precisely because of the way the index is created and maintained.

As not all the component stocks of the Dow ‘open’ at the same time, the index tends to open with the contributions of only a few stocks, and the previous day’s close of the rest. This effectively means that the open is pretty much the same as last night’s close (although big gaps up and down can occur).

There have been many attempts to create the ‘perfect’ Dow trading strategy, starting with ‘Dow Theory’ itself. Dow theory, while not a term ever used by the great man, nonetheless builds on his theories. There are 6 ‘laws’ of Dow Theory (that have never been either proven or disproven conclusively). Theses ‘rules of trading’ are:-

* The Market has three trends. These trends are – uptrend (successively higher highs), a downtrend (successively lower lows) and a reaction trend (price moves strongly one way, withdraws temporarily, then restarts in the original direction)* Each of these trends has 3 phasesDow Theory postulates that there is always an ‘accumulation phase’ (when smart money is buying or selling AGAINST the herd), a public participation phase (when the public realise the game’s afoot, and jump in too), and a distribution phase. This last phase is the important one – its when the smart money offloads their holdings onto the speculators who arrived too late, thereby crystallizing their profits, and causing the market to reverse.* The stock market discounts all newsAnother way of describing the ‘efficient market hypothesis’ which postulates that everything that is known about a stock is contained in the price of the stock. This should really be everything known about a stock by market participants in proportion to the strength of their involvement, of course.* Stock market averages must confirm each otherDow believed that the various stock market averages must confirm each other – if the manufacturing index was up, so should the transport index, and so on. If the averages start to diverge it is an early warning that something is up, and market turmoil may be approaching. This is probably the least respected rule in the set of 6 nowadays.* Trends are confirmed by volumeDow believed that when prices move on low volume, it wasn’t significant. Only with high volume comes confirmation that the move is definite. For high volume, almost ALL holders must be acting the same way. High volume in one direction therefore, tends to set the trend.* Trends exist until they have endedMarket ‘noise’ may cause a trend to appear to have faltered, but Dow believed that an established trend should be given the ‘benefit of the doubt’ until such time as it was obviously over. Determining WHEN a trend has ended, of course is the tricksy bit.

And this is where the dowstomper comes in! It’s important to note that the stomper indicator is not the same as the system peddled by insight.net – reports that it is a free insight.net clone are incorrect, as in my personal opinion, the dowstomper.com system is MUCH more accurate. And free, of course!

It works like this – the components of the Dow are used to make up the Index itself. Because of inefficiencies described above, the Index may ‘lag’ the components. This provides an early warning signal that the trend is about to change. Using this simple system over the last year, a single Dow futures contract is up over ,000 – that’s a LOT. To trade it, all you have to do is watch for a ‘long’ or ‘short’ signal. If the signal is LONG and you are currently long, you don’t need to do anything. If the signal is SHORT and you are short, once again, no action is required. If you are LONG and the signal is short, you need to close the long position and open a new short position. If the signal is LONG and you are currently short, you need to close the short position and open a new long one. When you open a position, set a fixed stop loss of 1% of the index behind your trade (so a long at 10,000 would have a stop at 9,900). And that’s all there is to it. No complicated calculations, pondering on stop loss sizes, wondering whether to take profits or constantly checking the market. Trading mechanically like this over the last year would have made you a fortune. Remember NEVER to trade with money you can’t afford to lose. Go get ‘em! Jason.