How to calculate Price Weighted Index
About this lesson
In this video, you will learn what the stock market index is and how they are calculated.
What a stock index is
A stock market index tracks the performance of a group of stocks with one number. Indexes differ in how much weight each stock gets.
Price-weighted indexes
In a price-weighted index, each stock counts in proportion to its share price. The best-known example is the Dow Jones Industrial Average (DJIA).
Index = Sum of the stock prices ÷ Divisor
At the start, the divisor is simply the number of stocks, so the index is a plain average of the prices.
Example
| Stock | Price |
|---|---|
| A | $25 |
| B | $100 |
Index = (25 + 100) ÷ 2 = 62.5
A 10% rise in stock B moves the index far more than a 10% rise in stock A, just because B’s share price is higher, not because the company is bigger.
Stock splits and the divisor
Suppose stock B splits 2-for-1, so its price drops to $50. Nothing about the company’s value changed, so the index shouldn’t change either. Solve for the new divisor d:
(25 + 50) ÷ d = 62.5 → d = 1.2
The divisor falls from 2 to 1.2 so the index stays at 62.5. After the split, stock B has less weight in the index.
Weaknesses
- A stock’s weight depends on its price, not the company’s size.
- Splits change the weights.
Most other indexes, including the S&P 500, are value-weighted instead.
Next: the value-weighted index.