What Is a Price-Weighted Index?

IBM will have a greater influence than INTC. Here’s why

By John Lansing


Several components within the Dow Jones Industrial Average are coming out with their latest earnings reports, making now a fitting time to study what really makes the index move.

The way the Dow Jones is structured makes it a “price-weighted index,” thus each stock influences the index in proportion to its price per share. The value of the index is generated by adding the prices of each of its component stocks, then dividing them by the total number of stocks. Stocks with a higher price will be given more weight and, therefore, will have a greater influence over the performance of the index.

For example, assume that an index contains only two stocks — one priced at $1 and one priced at $9. The $9 stock is weighted nine times higher than the $1 stock; overall, this means the index is composed of 90% of the $9 stock and 10% of the $1 stock.

Currently, the most expensive stock within the Dow Jones Industrial Average — and thus the one that carries the most weight — is IBM (NYSE:IBM).

By pure coincidence, IBM and Intel (NASDAQ:INTC) both went down 3.4% after they reported after-hours yesterday. In the case of IBM, it declined and stopped right here on this uptrend line. The low occurred right around July 2, when it was at about $180. IBM closed Tuesday at $211, and the last trade was $203.80.

As far as Intel goes, we can see that on the 300-minute chart that there was quite a wild swing yesterday.

It traded as far up as $23, then settled in after-hours trade just 20 cents above fresh new 52-week lows. However, because it’s only a $21 stock and not a $200-plus stock, Intel’s 3.4% decline will have nowhere near the negative impact on the Dow as IBM’s 3.4% decline.

Both had a negative reaction, but now that we’re having more and more Dow components report, these are probably two biggies — Intel because of its reach in tech, and IBM because it is the most expensive stock in the Dow.

Technicians will be keeping a close eye on these two.

John Lansing tracks the charts all day and offers expert technical analysis in his day trading, options and trading services: Power Trading at the Open, Parabolic Options and Trending123.

Article printed from InvestorPlace Media, https://investorplace.com/2012/10/what-is-a-price-weighted-index/.

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