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We are currently integrating a blog to our Rails application. I though that we should opt for a subdomain instead of having Rails and Wordpress coexist on the same domain. They do not allow to do this because it is bad for SEO. Is that correct?

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Who are 'They'? – Sam Oct 22 '09 at 18:22
Don't really thin SEO is a sysadmin thing... – Zoredache Oct 22 '09 at 18:43

If you want to be ranked highly in search engines, you need to do one thing: Produce interesting high quality content that people will want to read and link to. Make the content easy to find and read, and the search engines will do the rest. Most SEO advice is rubbish, a waste of money and in same cases can actively harm your ranking.

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Most SEO consultants are overconfident hucksters who are good at telling the people who sign checks there's an easy way to get rich(er), and 98% of them shouldn't be involved in making technical decisions, but I think it's still true (for Google, at least) that PageRank for wouldn't be credited to, because of an exploit search spammers (eg SEO Consultants) used a couple years ago. A blog full of good, relevant content might pull in more links (and thus improve pagerank), though you can also share that pagerank with your main site by linking back to it in the header/sidebar of the blog with relevant keywords.

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