What is Weighted?
Weighted refers to the mathematical practice of adjusting the components of an index to reflect the importance of certain characteristics.
How Does Weighted Work?
Here is information about five stocks.
If we wanted to create an unweighted index of the price performance of these five companies, we might average their stock prices and call it a day (i.e., we would calculate the average as $8.60).
However, this unweighted average doesn’t take into account the issuers’ actual sizes or the number of shares outstanding (in other words, without reflecting the issuers’ true heft in the economy). The tiny companies can sway the index as much as the more significant companies. Accordingly, if one of the higher-priced stocks (Company D, in our example) has a huge price increase, the index is more likely to increase even if the other, more meaningful companies in the index decline in value at the same time.
Thus, we could create a weighted index to give more weight to the bigger issuers. We could do this by multiplying the share price by the shares outstanding, summing the totals, and then dividing by the total shares outstanding:
Why Does Weighted Matter?
In the finance world, some indexes are weighted and some are not. It is important to understand how indexes are weighted so that you can understand what influences those indexes, what the index really conveys, and whether the index is relevant to your investment objectives.