🚨 I’ll be live at 12:30 p.m. ET🚨
We’ll cover a look at an entirely different strategy for targeting the massive run in Gold without buying the physical metal, the specific market phenomenon we’ve tracked for 17 months, our direct attack plan for today’s gold opportunity and more [tap to join]
The Dow Jones Industrial Average (DJIA) finally pushed above 50,000 last week.
It had attempted the move seven different times before failing, so when it finally broke through, even I thought it probably wouldn’t stick. Yet here we are, and the index has managed to hold above that level. I’ll admit, that’s impressive.
What isn’t impressive is the way the DJIA is constructed.
Nearly every major index traders follow today uses market-cap weighting.
The Russell 2000 (RUT), the S&P 500 (SPY), the Nasdaq 100 (QQQ), the DAX Performance Index (DAX) and the S&P MidCap 400 (MDY) all give greater influence to larger companies.
That makes intuitive sense because bigger companies have a larger impact on the overall market.
The DJIA is the exception.
Instead of weighting companies by their size, it weights them by their share price. That means the stocks with the highest nominal prices have the greatest influence on the index, regardless of how large or important those businesses actually are.
That’s where the distortions begin.
The Fatal Flaw in the Dow’s Design
Because the DJIA is price weighted, it can behave in ways that don’t accurately reflect what’s happening across the broader market.
Imagine a stock trading at $9 per share suddenly climbing to $900. Under the Dow’s methodology, that stock could end up exerting more influence on the index than companies such as 3M (MMM), JPMorgan Chase (JPM), Home Depot (HD) and Coca-Cola (KO) combined.
Not because it’s a larger company.
Not because it’s more profitable.
Not because it matters more to the economy.
Simply because its share price is higher.
And with only 30 components in the index, it doesn’t take much to move the entire benchmark. If the DJIA is having a terrible day while other indexes remain relatively healthy, there’s a good chance a handful of high-priced components are responsible for most of the damage.
The methodology creates another strange side effect.
Companies don’t necessarily get removed because they’re weak businesses. Sometimes they get removed because their stock prices are too low to meaningfully influence the index.
Alcoa (AA) is a classic example. It spent years in the DJIA but eventually became a candidate for removal because its share price had fallen into the teens.
Under a price-weighted system, lower-priced stocks contribute very little movement to the index.
That’s a flaw built directly into the design.
Other Indexes Aren’t Perfect Either
The DJIA may be the strangest major index, but it’s not the only one with quirks.
Take the Russell 2000, for example. It’s often treated as the benchmark for small-cap stocks, yet it’s constructed from the smallest companies within the broader Russell universe.
Depending on your perspective, that means you’re measuring a segment of the market that naturally contains more risk and weaker businesses than large-cap indexes.
Every index has limitations. No benchmark perfectly captures the market.
The difference is that most major indexes at least attempt to reflect economic reality through market-cap weighting. The DJIA continues to rely on a methodology that can create outsized distortions based solely on stock price.
If you want a clearer view of the market, SPY remains a solid benchmark for large caps. NDX is useful for tracking growth and technology leadership. RUT can help gauge small-cap participation.
The DJIA may still generate headlines, but understanding how it’s built is essential before treating it as a reliable measure of market strength.
Geof Smith
Geof Smith TradingÂ
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*This is for informational and educational purposes only. There is inherent risk in trading, so trade at your own risk.Â
P.S. Live at 12:30 PM ET: How We’re Going After Gold Today!Â
We’re going after yet another Gold opportunity today!
But before we even get that chance to enter the trade, I’ll be live at 12:30 p.m. ET to show you exactly what we’ll be trading.
By now, you already know that the best way to take advantage of the amazing run Gold has seen over the last 5 years is not to buy the actual metal.
For about 17 months, we’ve been targeting an entirely different phenomenon…
Giving us a shot at $800 (on a $5K stake) every week!
I can’t make trading guarantees, of course.
But nothing will stop us from going right after gold today.
So if you want to see what our attack plan is, and even how you can join in for the ride
