Weighted price index


A weighted price index is a type of stock index that is calculated simply as the arithmetic mean of the price of the securities that make up the index, that is, it adds the price of all the shares that make up the index and divides it by the number of stocks that make up the index:

Weighted price index = Sum of the price of all shares / Number of shares

It reflects the variation in performance if we had one share of each security in the index. Therefore, the performance of this type of index is highly influenced by the values ​​that have a very high price of their shares.

Two important indices that use the weighted price method are the Dow Jones Industrial Average (DJIA) and the Nikkei Dow Jones Average.

Advantages of the weighted price index

Its main advantages are that it is very easy to calculate and that there are a large number of historical prices, so it is easier to go back to see the performance of that market.

Disadvantages of the weighted price index

Price-weighted indices do not reflect a typical stock portfolio, as it is very rare to build a portfolio with the same number of stocks of each security.

The big problem with these types of indices is that the stocks with the highest prices are going to have more influence on the value of the index, regardless of their actual influence on the economy. The stocks that rise the most in price tend to perform splits, so the impact of that action on the index will be minimized and therefore, the less successful stocks will end up being given more importance.

Example of a weighted price index

Suppose we build a weighted stock index based on the prices of 3 stocks. Stock prices on January 1, 2017 are:

  • Value A: € 10
  • Value B: € 30
  • Value A: € 80

The value of the index on January 1 would be (10 + 30 + 80) / 3 = 40. If the prices on December 31, 2017 are:

  • Value A: € 20
  • Value B: € 25
  • Value A: € 45

The value of the index as of December 31st would be (20 + 25 + 45) / 3 = 30. Therefore the return of the index has been -25% (30/40 - 1), despite the fact that there is a share that has doubled in price. This is because the index is highly dependent on Value A, which has a higher price for its stock.

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