Learning about the Dow Jones index of the US stock market and its correlation with forex and other financial markets
What is the Dow Jones Index?
The Dow Jones Industrial Average (DJIA), commonly known as the Dow Jones, is one of the oldest stock indices in the world. The DJIA was founded by Charles Dow, one of the founders of Dow Jones & Company in 1896. Dow Jones includes 30 large and reliable companies in various industries, so a change in one sector alone does not impact the trend of this index significantly. The most well-known of these companies are McDonald's and Microsoft. At first, the index was calculated by adding up the prices of 12 stocks and dividing by 12, resulting in a simple average. Over time, changes such as mergers and stock splits were added to the index, leading to the conclusion that the higher the value of a company's stock, the more significant the impact of that company on the Dow Jones index. Of course, some companies, like Facebook, are not included in the Dow Jones index due to their high impact compared to other companies.
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Is it better to trade stocks or Dow Jones?
As a person who is not an American citizen, you cannot directly buy shares of American companies and be a shareholder of these companies, but you can trade stocks of companies listed on the Dow Jones or other companies through the conditions provided by brokers. However, trading companies' individual shares is not suitable for everyone and has a higher risk because your investment depends on that company's fate. If the company suffers a financial crisis, you are at risk of losing capital, and you also need to be aware of the specific risks of the companies you invest in. But Dow Jones index trading is more logical and less risky than trading a specific company's stocks, considering that it is a collection of different companies' shares.
Calculation of each lot's value for the Dow Jones trade
Dow Jones calculations for trading are a bit complicated, and here we try to explain to you as simply as possible how to use it in your trading. The minimum volume for this indicator is one micro lot (0.01). If you trade in one micro lot volume, you will earn or lose 10 cents for each unit that the index changes. If you trade a mini lot (0.1), you will make or lose $1 for every dollar the index produces. When trading a half lot, each unit of the index movement will result in a $5 profit/loss. Remember that this indicator is explained for trading in the broker in US dollars.
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Using similar indicators to get confirmation
In addition to the Dow Jones, there are Nasdaq and SPX500 indices in the US stock market, which indicate the market's state. The Nasdaq and SPX500 indices analyze more stocks than the Dow Jones, and give the analyst a more general view of the US stock market's state. There is a close relationship between the Dow Jones, the Nasdaq and the S&P500 index, which each covers a significant part of the US economy. When these indicators are analyzed jointly and the data obtained from them is compared, it can provide a more complete view of the market.
Advantages of using Dow Jones:
- Dow Jones gives you an overview of the US stock market, which you can recognize the US stock market's behavior to a large extent by analyzing it.
- Trading this index is less risky than trading a specific stock because it includes a set of stocks.
- It gives the trader a good perspective for trading currency pairs whose one side is the USD.
Disadvantages of the Dow Jones index
- Trading this index is unsuitable for novice traders, and analyzing it requires skill in technical and fundamental analysis.
- The volume of its fluctuations is higher compared to currency pairs, and the trading of this index requires a large amount of capital.
Dow Jones Correlation with Forex
Forex (Foreign Exchange) is the market for buying and selling currency pairs. Generally, currency pairs are divided into two Major and Minor Currency Pairs . While the Dow Jones tracks the growth rate of the US economy. The forex market is a reflection of economies' state around the world. The correlation between Dow Jones and Forex usually occurs due to economic indicators such as growth rate, GDP, interest rate and unemployment rate that affect the stock market and currency. For example, when the US economy is strong, international investors often buy more US assets, including stocks in the DJIA. This increase in demand for US assets usually leads to a strengthening of the US dollar as foreign investors need to buy dollars to buy these assets. Strengthening the dollar's value leads to currency pairs whose main currency is the dollar ascending and the currency pairs whose opposite currency is the dollar declining. However, it is significant to note that the correlation between Dow Jones and Forex is not always direct. Various factors, such as geopolitical events, economic policies, etc., can affect the correlation between Dow Jones and Forex.
Dow Jones correlation with other financial markets
The DJIA also has complex links with other financial markets, such as bond and commodity markets. For example, when the DJIA is bullish, it indicates increased economic activity, leading to potential inflation. To control inflation, the central bank may raise interest rates, which makes bonds and other fixed income securities more attractive to trade. That could lead to a sell-off in the stock market and create an inverse relationship between the Dow Jones and the bond market. Similarly, commodity markets are also linked to the DJIA. In a thriving economy, demand for commodities such as oil, metals, and agricultural products often increases, causing their prices to rise. That could affect DJIA stocks, especially those tied to commodities such as manufacturing and energy companies.
The Dow Jones Index serves as a barometer for the US economy and has a complex relationship with forex, bond and commodity markets. By understanding these relationships, investors can make more informed decisions and build better diversified portfolios. However, these correlations are complex and influenced by various factors.