What it is:
How it works (Example):
For example, let's assume that the following companies are in the XYZ price-weighted index:
A price-weighted index is simply the sum of the members'prices divided by the number of members. Thus, in our example, the XYZ is: $5 + $7 + $10 + $20 + $1 = $43 / 5 = 8.6.
Why it Matters:
In a price-weighted index, stocks with higher prices receive a greater weight in the , regardless of the issuing company's actual size or the number of . Accordingly, if one of the higher-priced stocks (Company D, in our example) has a huge price increase, the is more likely to increase even if the other stocks in the decline in value at the same time.
The Dow Jones Industrial Average is probably the best-known and most widely followedin the world. At its inception, the DJIA started with just 12 stocks and was priced at 40.94, a far cry from today's levels. The Dow now consists of just 30 stocks, making it one of the least diversified around. The calculation behind the actual Dow value is quite complex, but essentially it is derived by summing up the prices of all 30 member stocks and then dividing that figure by a "magic number" (also referred to as the divisor).
[InvestingAnswers Feature: Dow Know-How -- What Moves the World's Most-Watched Average?]
Anmight establish an arbitrary divisor in order to start the off with an even number (100 or 1,000, for example). In an effort to maintain the DJIA's continuity, the divisor changes over time to reflect changes in the Dow's 30 component stocks.