What Is the DAX 40 and How to Trade It?

The DAX 40, also known as the DAX Index, is a blue-chip stock index following the largest German companies listed on the Frankfurt Stock Exchange. It’s also a reliable indicator of the country’s economic strength. It’s considered to be the benchmark stock market index for the German economy.

What Is the DAX 40?

The index tracks the 40 largest German companies in terms of market cap and liquidity. DAX is short for Deutscher Aktien Index 40 and it was established with a base value of 1,000 in 1988. Since 2006, the Xetra trading venue has been computing the index’s price every second.

When the DAX 30 became the DAX 40 on September 20 2021, the Deutsch Boerse admitted ten more companies to the index, meaning a slightly broader range of sectors covered, as well as other regulatory provisions. The DAX 30 became the DAX 40 on September 20 2021.

Additions to the index were Airbus, Zalando, Siemens Healthineers, HelloFresh, Symrise, Sartorius, Porsche Automobile Holding, Brenntag, Puma and Qiagen.

The DAX is a performance-based index as it incorporates data on company dividends, capital income and cash outflow, which are included in the net stock price, while a pure price index would overlook corporate distributions.  
 
Similar to DAX, other blue-chip stock indexes are the CAC 40 in France, the FTSE 100 in the United Kingdom, and the S&P 500 index in the United States. 
 
Since its inception at the end of 1987, the DAX has mirrored other indices during major economic events throughout history, including the tech bubble in 2000, significant lows in 2003, as well as other fluctuations over in subsequent years. The index plunged in 2008 amid the global financial crisis and did again during the global Covid-19 outbreak. 
 

How Is the Index Calculated?

The DAX 40 is computed through the free-float methodology, which means that it takes into consideration only the readily available shares and it doesn’t take into account shares that are untradable, like those owned by governments.
 
Like other blue-chip indices, the DAX Index is also weighted by market cap, so companies with higher market caps have more influence on its value. Companies included in the DAX can have a maximum weight of 10%.
 
The prices used to compute the index come from Xetra, an electronic trading system. The index tracks the performance of Germany's 40 biggest companies by order book volume and market capitalisation.

DAX Components

Here are some of the most popular components of the DAX 40:

• Adidas AG (ETR: ADS) - a popular design and clothing company headquartered in Herzogenaurach, Germany.
• ​Airbus SE (EPA: AIR) - an international pioneer in the aerospace sector designing manufacture and deliver industry-leading commercial aircraft.

• BASF SE (ETR: BAS) - one of the largest chemical producers in the world, with 390 production plants around the world. 

• Bayer AG (ETR: BAYN) - a pharmaceutical company that produces some of the most popular pain relief drugs.  

• BMW AG (ETR: BMW) - a well-known automaker that has manufactured various award-winning models. 

• Deutsche Bank AG (ETR: DBK) (NYSE: DB) - one of the largest banks in the world, operating in 58 countries in Europe, Asia and the Americas. 

• Siemens AG (ETR: SIE) (NYSE: SI) - an electronics manufacturer and electrical engineering services provider operating in a wide array of market industries. 

• Volkswagen AG (ETR: VOW) -  the largest automobile manufacturer by worldwide sales in 2016 and 2017.

To be included in the DAX 40, a company must first be listed in the Prime Standard segment on the Frankfurt Stock Exchange. Companies that belong to this segment have to meet higher standards of transparency than companies listed on the General Standard segment. 
 
Additionally, the company should be continuously traded in Xetra with a public float of at least 10%. Another requirement is to have an office registered in Germany with most of its volume of shares traded in Frankfurt, and be headquartered in one of the EU countries.

Correlations

According to Blackwell Global, the DAX 40 has a more than 90% correlation with major US stock indices and a 70% inverse correlation to the Euro. The correlation between the DAX and its US counterparts has deviated at certain periods, for example when the 50-day correlation between the two went negative in 2018, indicating that underlying trends affecting worldwide assets temporarily changed.
 
For instance, if the EUR/USD currency pair advances, the DAX index usually depreciates, and on the other hand, when the Euro depreciates against USD, the DAX moves up. This phenomenon  is used by traders to develop a successful trading strategy.
 
Another interesting fact is that the DAX is quite responsive to the European Central Bank or ECB policies. Major news releases in the Eurozone are likely to affect the index. This is because the correlation strategy helps mitigate risk since you’re making decisions based on proper information. 
 
The correlation between different currency pairs and indexes can range between -1 to +1, and if the two instruments advance in the same direction, that’s an indicator of an ideal positive correlation. On the other hand, an ideal negative correlation would mean that the pairs or indexes will always advance in the opposite direction. 
 
Finally, if the correlation coefficient is 0, the directions of two currency pairs or indexes are completely independent. While understanding the DAX, correlation strategy can be of great help for risk management, traders and analysts should know that correlation only matters when it comes to the directional relationship and not the scale of the movement. 
 
For example, if the Euro is falling sharply, the DAX will likely rise, but not as sharply. Also, when developing your correlation strategy, keep in mind that correlations sometimes can fade unexpectedly.

Historical Performance

As a leading German index and home to major German stocks, including BMW, Deutsche Bank, VW and Siemens, the DAX 40 has always been closely followed by investors. 
 
The DAX 40 posted large gains, tracking other global indices during the 1995 dotcom bubble when stocks were led higher by U.S. technology stock valuations.
 
In the five years between 1995 and 2000, the DAX Index gained 300%, rising to a record high of 8,000 from about 2,000. In the next seven years, the price action traded in a V-shaped fashion, plunging to 2,220 in 2003, before rising again to match the 2000 high in 2007.

The 2008 global financial crisis facilitated another pullback before DAX 40 started to ascend again. This led to a continuous uptrend with three cyclical corrections in 2011, 2015, and 2018. 
 
In 2020, the DAX Index was trading at record highs before the Covid-19 pandemic triggered the fastest stock market selloff in history. The DAX 40 went from trading at 13,800 to 8,250, dropping 40% in just four weeks’ time. 

Spread and Leverage

While it carries significant risk, Institutional and retail investors also tend to spread-bet on the DAX. As a derivative product, spread betting doesn’t let you take ownership of the underlying asset. Instead, traders speculate on whichever direction the price will move in the future. 

Leverage is a key element of spread betting, as it allows traders to increase market exposure. Hence, investors tend to leverage DAX to potentially magnify profits, but also losses. For this reason, it is important to create a sustainable risk management strategy, bearing in mind the amount of capital that you are putting at risk.

Summary

• The DAX 40, also known as the DAX Index, is a benchmark German stock market index following the 40 largest German companies.

• The DAX index is home to major German stocks, including BMW, Deutsche Bank, VW and Siemens.

• DAX is the German counterpart of the French CAC 40 index, the British FTSE 100, and the U.S. S&P 500 index.

• Understanding the correlation between the DAX and other indices in some detail can be of great help when working on a trading strategy.