Price-Weighted Index
Candlefocus EditorFor example, suppose a price-weighted index contains 10 stocks with the following prices:
Stock A: $50 Stock B: $100 Stock C: $75 Stock D: $25 Stock E: $125
The index would be the average of the prices, which would be 75 (50 + 100 + 75 + 25 + 125 / 5). Stock B, with a price of $100, would comprise more than a third of the index due to its higher price.
Price-weighted indexes are weighted based on the stock prices, without taking into account the size of the company. Therefore, by giving more influence to the stocks with higher prices, the index could be manipulated. If a company artificially inflates its share price, the price-weighted index would be impacted to a greater extent because the stock would have more influence. This makes price-weighted indexes less reliable for measuring a market’s performance than when using other types of indexes, such as market-capitalization weighted indexes.
Price-weighted indexes are still popular and used to track the performance of a specific market or industry. The Dow Jones Industrial Average (DJIA) is an example of a price-weighted index which tracks the performance of 30 large publicly traded companies in the US.
Overall, Price-weighted indexes are a useful tool for tracking the average stock price of a given market or industry and can still provide useful information. However, it is important to remember that price-weighted indexes do not take into account the size of the company, and as such, can be manipulated and are therefore less reliable than other index types.