How to Calculate a Stock Price Index
A stock price index is a good way to measure any subsection of the stock market, from a particular industry to market size. Common indexes are the Wilshire 5000 or the S&P 500. The most popular and quoted index is the Dow Jones Industrial Average (DJIA), which is a price-weighted index of 30 blue chip stocks.
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Instructions
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Calculating a Stock Price Index
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1
Gather the stock price information for five listed stocks of your choice going back 20 days or one month. You can find this information on Yahoo! Finance by entering a ticker symbol in "Get Quotes" and clicking on "Historical Prices" in the left-hand pane. You will also need the number of shares outstanding.
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2
Choose a starting point or base period for your stock. It can be the first day of the range selected in Step 1. Create three columns in a spreadsheet or on paper. Make one column for the date (Column A), one for the stock (Column B) and one for the price of the stock (Column C).
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3
Sum Column C (the price of the stock) and divide by five (the number of stocks in your index). This is your price-weighted average. Those stocks with higher prices will affect this average more than price fluctuations in lower-priced stocks. It is the easiest way to calculate stock price index; however, it does not take the size of the company into consideration.
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4
Calculate market value weighted index. Unlike the price weighted index, the market value weighted index considers company size. Create a Column D with the number of shares outstanding for each stock in the price weighted index. Multiply the number of shares (Column D) by the price (Column C). This is the market capitalization. Let's name this Column E. Sum Column E and divide by five. This is the market value weighted index. A small change in price for a big company will have a greater affect on the value of the overall index value for a market weighted index. This is also known as a capitalization value-weighted index.
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5
Calculate a modified market capitalization stock index. This is a combination of the price and market-value weighted index. It is calculated in the same way as a market-value weighted index, but a cap (or limit) is set on the largest stocks. Using the example above, you can use an arbitrary cap of 25 percent of the total index value. That is, any stock that represents over 25 percent of the average of Column E should be capped for price fluctuations. This has the affect of "un-weighting" the larger market cap stocks in your index.
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Tips & Warnings
Due to Jensen's Alpha, a measure of return over the average, portfolio fund managers are often judged based on their ability to outperform the major indices, which all represent an average. The academic history behind Jensen's Alpha suggests that only 20 percent of investors are able to achieve a higher return (alpha) than the average (stock index).
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