Stock Market indicators:
Stock indices can be organized by weighting the sample of stocks. The stock indicators can be of four types: price-weighted average, volume-weighted average, unweighted or equal weighted price index and free-float market capitalization.
Price-Weighted AveragePrice-weighted average is the arithmetic average of current prices. The Dow Jones Industrial Average (DJIA) is the most popular price-weighted average. DJIA is unique in the price weighted series rather than market capitalization weighted series. The component weightings are affected only by changes in the stocks' prices, in contrast with other indexes which give weightings that are affected by both price changes and changes in the number of shares outstanding. When the DJIA was initially created, its values were calculated by simply adding up the component stocks' prices and dividing by the number of components. The rise in stock prices in terms of percentage will have uneven impact on calculation of index giving more weightage to higher price stocks. Such that, a $1 appreciation in the price of a small stock of $10 and $1 appreciation of a stock of $100 will have same implication on the index movement even though their percentage of appreciation differ. Moreover, the market capitalization of companies has no influential role to play in calculation of the index.
Therefore, the DJIA is not the true indicator of US industrial economy and the stock market as a whole. Later, the practice of adjusting the divisor was initiated to smooth out the effects of stock splits and other corporate actions.
Two kinds of averages are used in constructing share price indices - arithmetic mean and the geometric mean. Between the two averages, the arithmetic mean is more widely used. However, before we evaluate these methods, it must be emphasized that the indices based on averages are not the same as the general averages.