tldr: The Dow 30 index is a bit absurd, however it's not as bad as it seems because of portfolio theory.
The Dow 30 correlates highly with the S&P500 index over medium-long periods of times (approx more than a month) [1]. This correlation is due to the fact that the 30 stocks that are selected are arbitrary but not random. They are selected by a human process which considers which companies contribute an important factor to the overall market [2]. Of course this process will be imperfect because it's vague, however it gets pretty close.
Don't forget, according to findings from portfolio theory, it's possible to replicate an index with only a small subset of the components of that index [3]. There's a whole field of work describing how to do this [search google for 'replicating index'],
In fact, replicating an index with a small number of stocks is exactly how 'smart trading' companies like wealthfront and bettermint make money. They find multiple non-overlapping subsets of the S&P500 which correlate strongly with S&P500 performance. Then they buy subset A, and if a loss is incurred in any month, they sell subset A and buy subset B. Since A and B are highly correlated with each other (ideally r>.99) and with the S&P500, the investor should expect the same return in the future, however can book a capital loss which creates a tax refund. Shifting from subset A to subset B avoids a wash-sale allowing the capital loss to be recognized [4].
The Dow 30 is certainly not an optimal index, however it's a case study in showing how selecting the "top" companies for some reasonable definition of "top" will earn a return approx. equal to the market (represented by S&P500) no matter the strategy (in this case price-weighting instead of mkt cap weighting can be considered a strategy).
The reason it's cited so widely is that there's a lot of historical data on the Dow 30, whereas every other index is less reported.
[1] Yahoo Finance comparison of Dow 30 vs. S&P500 chart http://finance.yahoo.com/chart/%5EDJI#eyJjb21wYXJpc29ucyI6Il...
[2] Dow 30 index is built and maintained by a subsidiary of News Corp. https://en.wikipedia.org/wiki/S%26P_Dow_Jones_Indices.
[3] http://www.etf.com/etf-education-center/21038-how-to-run-an-...
[4] http://www.investopedia.com/terms/w/washsalerule.asp
The Dow 30 correlates highly with the S&P500 index over medium-long periods of times (approx more than a month) [1]. This correlation is due to the fact that the 30 stocks that are selected are arbitrary but not random. They are selected by a human process which considers which companies contribute an important factor to the overall market [2]. Of course this process will be imperfect because it's vague, however it gets pretty close.
Don't forget, according to findings from portfolio theory, it's possible to replicate an index with only a small subset of the components of that index [3]. There's a whole field of work describing how to do this [search google for 'replicating index'],
In fact, replicating an index with a small number of stocks is exactly how 'smart trading' companies like wealthfront and bettermint make money. They find multiple non-overlapping subsets of the S&P500 which correlate strongly with S&P500 performance. Then they buy subset A, and if a loss is incurred in any month, they sell subset A and buy subset B. Since A and B are highly correlated with each other (ideally r>.99) and with the S&P500, the investor should expect the same return in the future, however can book a capital loss which creates a tax refund. Shifting from subset A to subset B avoids a wash-sale allowing the capital loss to be recognized [4].
The Dow 30 is certainly not an optimal index, however it's a case study in showing how selecting the "top" companies for some reasonable definition of "top" will earn a return approx. equal to the market (represented by S&P500) no matter the strategy (in this case price-weighting instead of mkt cap weighting can be considered a strategy).
The reason it's cited so widely is that there's a lot of historical data on the Dow 30, whereas every other index is less reported.
[1] Yahoo Finance comparison of Dow 30 vs. S&P500 chart http://finance.yahoo.com/chart/%5EDJI#eyJjb21wYXJpc29ucyI6Il...
[2] Dow 30 index is built and maintained by a subsidiary of News Corp. https://en.wikipedia.org/wiki/S%26P_Dow_Jones_Indices.
[3] http://www.etf.com/etf-education-center/21038-how-to-run-an-...
[4] http://www.investopedia.com/terms/w/washsalerule.asp