Index weighting

One of the two halves of an index rule, the other being which companies are on the list. Three schemes cover almost everything published. Capitalisation weighting counts each company in proportion to its market value, usually adjusted for free float so that shares locked away with founders or governments are excluded. Price weighting counts each company in proportion to its share price alone. Equal weighting gives every constituent the same share regardless of size.

Under capitalisation weighting a constituent's weight is its free float market value divided by the total across the list, so the largest few companies can account for a substantial part of the index and a move in one of them shows up in the level. Price weighting divides each share price by a common divisor, which means a company with a high share price counts more than a far larger company with a low one, an artefact of share counts rather than of economics. Equal weighting drifts as prices move and has to be reset on a schedule, so it carries a rebalancing effect the other two do not.

What this most often explains is two indices on the same market disagreeing. A capitalisation weighted index and an equal weighted index built from an identical list report different returns over the same period, and neither is wrong, because they are answering different questions: one measures the market's aggregate value, the other the average constituent. Many providers also cap the weight any single constituent may reach, so a published rule can depart from strict capitalisation weighting without saying so in the name.