Price weighted

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A price-weighted index is one where the components are included based on their price. For a stock market index this implies that stocks are included in proportions based on their quoted prices. Therefore, a stock trading at $100 will be making up 10 times more of the total index compared to a stock trading at $10. This is different from a market weighted index (also known as capitalization weighted) where stocks are included based on the equity market values of the underlying companies, e.g., the quoted stock price multiplied by the number of stocks outstanding.

Many believe that a price weighted index will not accurately reflect the evolvement in underlying market values because, simply, the $100 stock above might be that of a small company and the $10 stock that of a large company. A change in the price quote of the small company will thus drive the price weighted index (as it makes up a large part of the index) while the combined market values will remain relatively unaffected without changes in the price quote of the large company.

The Dow Jones Industrial Average is an example of a price-weighted stock market index.


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