Many are familiar with the Dow Jones Industrial Average (DJIA) but how can you trade it and make money? The DJIA consists of 30 major US stocks so theoretically you can just go to your broker and buy (or sell) these 30 stocks individually. This is fine but not too efficient when there are many better ways to do it.

Dow Jones Industrials Average (DJIA)

There are quite a few ways to take a position, either long or short, on the DJIA. The easiest way is possibly going long or short the DIA, or Diamond ETF. This ETF will track the movement of the underlying almost perfectly and is one of the most popular methods of hedging or taking an outright position on the Dow. If you are very bullish, you can buy the Ultra Dow30 ETF called DDM which provides 200% of the daily movement of the DJIA.

If physically shorting an instrument or ETF makes you uncomfortable i.e. possibly due to the requirement to have a margin account, a good way then to circumvent this requirement is to go long an ETF which is the inverse of the Dow. Take for example the ETF with the ticker symbol, DOG. This ETF is inversely co-related to the DJIA. However, if you want to adopt a more aggressive short stance in the markets, you can take a look at the Ultra Short ETF with the ticker symbol DXD, which is 200% inversely co-related to the daily movements of the Dow.

Other Major US Indexes

Similarly, you can take long or short positions on the other major indexes like the S&P 500, Nasdaq 100 and the Russell 2000 as follows:

S&P500

• Long ETF – SPY
• Ultra Long ETF – SSO
• Short ETF – SH
• Ultra Short ETF – SDS

Nasdaq 100

• Long ETF – QQQQ
• Ultra Long ETF – QLD
• Short ETF – PSQ
• Ultra Short ETF – QID

Russell 2000

• Long ETF – IWM
• Ultra Long ETF – UWM
• Short ETF – RWM
• Ultra Short ETF – TWM

Using Options on ETFs

The instruments that give the best bang for the buck, in terms of leverage, have to be options on ETFs. Take for example if you have a view that the Dow Jones index will rally above 10000 points in the next 2 months. The obvious way to take advantage of this view is to buy DIA.It will cost you about $90 per share (at Jul 09 prices). You can also short the inverse ETFs, but that will require a margin account and all the associated risks of a margin account.The other alternative is to buy a Call Option on the DIA. A Sep 09 $90 call option only costs $3.20 per option contract. If the Dow does go above 10000 in Sep 09, the call option stands to more than double! The main drawback of options, however, is their limited lifespan as they expire after a period. The closer an option gets to its expiry date, the lower is its time value, although its intrinsic value may more than make up for it, if the direction and timing of purchase is correct.

All 3 of the major ETFs i.e. DIA, SPY & QQQQ have options with good liquidity to easily hedge or take an outright position on the indexes. Remember, the major drawbacks of options are the limited lifespan and the decay in value.

Using Stock Index Futures

Stock index futures also allow one to take positions in the US stock markets. This option should only be attempted if one is experienced in the market and is well capitalized. Futures are highly leveraged instruments with a limited lifespan and normally require a separate futures account to trade from. The following are the futures that can be used to trade the major indexes:

Dow Jones Industrial Average – YM
S&P 500 Index – ES
Nasdaq 100 Index – NQ

Conclusion

Taking a position on the indexes can sometimes mitigate risks as compared to buying an individual company’s stock. An unfortunate bad earnings report or analyst downgrade of a company can very quickly affect the company’s stock price and damage one’s portfolio. A position on the indexes will not be too sensitive to adverse happenings at the individual company level.