How is index calculated

The index calculation methodology includes equities that can be traded on Tadawul. Restricted shares shares that are not allowed to be traded during a period. Shares acquired through buy-back by a listed company. Shares owned by members of the Board of Directors. Apply market research to generate audience insights. Measure content performance.

Develop and improve products. List of Partners vendors. By Adam Milton Full Bio Adam Milton is a professional financial trader who specializes in writing and curating content about commodities markets and trading strategies. Through both his writing and his daily duties in trading, Adam helps retail investors understand day trading. He has experience analyzing various financial markets, and creating new trading techniques and trading systems for scalping, day, swing, and position trading.

Learn about our editorial policies. Updated February 25, Reviewed by Gordon Scott. Article Reviewed November 30, Learn about our Financial Review Board. Fact checked by Hans Jasperson. Article Fact Checked January 06, Hans Jasperson has over a decade of experience in public policy research, with an emphasis on workforce development, education, and economic justice. His research has been shared with members of the U. Instead of tracking each stock separately, it would be much easier to get and track a single number representing the overall market constituting both the stocks.

Applying the initial concept of Dow to our hypothetical example of AB index:. Therefore, the index value remains unchanged. This indicates that price-weighted indices like Dow Jones and Nikkei depend on the absolute values of prices rather than relative percentage changes. AB index wants to expand and increase the number of constituents from two to three, to include the newly listed C company stock in addition to the existing A and B stocks. From the perspective of the AB index, a new stock's coming onboard should not lead to a sudden jump or drop in its value.

If it continues with its usual formula, then:. This is a sudden dip in index value from the previous This would not be a very useful reflection of the overall health of the market. To overcome this calculation anomaly problem, the concept of a divisor is introduced. The divisor allows the index values to maintain uniformity and continuity, without sudden high-value fluctuations.

The basic concept of a divisor is as follows. Simply because a new constituent is getting added, this should not justify high-value variations in the index. It should be such that the following condition should hold true:. That is, assuming that the stock prices from the old index are held constant, the addition of a new stock price should not affect the index. So on the day when the stock C is included in the AB index, its correct and continuous value becomes:.

This same value on the fourth day makes sense because we are assuming that the stock prices of A and B have not changed compared to the third day, and just because the new, third stock is added, this should not lead to any variations. Going forward, this new value of 2.

It will change only in the case of new constituents getting added or deleted or any corporate actions taking place in the constituents example below. Suppose that stock B takes a corporate action that changes the price of the stock, without changing the company valuation. In essence, the company has not created or reduced any of its valuations because of this stock-split corporate action. This is justified by the number of shares tripling and the price coming down to a third of the original.

However, our index is solely price-weighted and does not account for share volume change. This is way below the earlier index value of Here again, the divisor needs to change to accommodate for this change, using the same condition to hold true:. Using this new divisor value,. Arriving at the same previous day value validates the correctness of our calculations.

This new 1. The same calculation would apply for any corporate action affecting the stock price of any of the constituents. The first step in this methodology is to compute the free-float market capitalization of each component in the index. This calculation takes the number of outstanding shares of each company and multiplies that number by the company's current share price, or market value.

As such, this excludes nominal shares allocated with exercise rights to executives and other interested parties. For example, Apple reported This value is used as the numerator in the index calculation. Calculating the individual market weights shows how the underlying stocks affect the index. The individual market weights are calculated by dividing the free-float market capitalization of a company in the index by the total market capitalization of the index.

This implies that Apple makes up roughly 6. Accessed Aug. Investing Essentials. Stock Markets. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page.