The process of determining a specific stock market benchmark value by summing the prices of included stocks and then dividing by a divisor is a method that gives higher-priced stocks greater influence on the index’s value. For example, if Stock A is priced at $100 and Stock B is priced at $50, Stock A will have twice the impact on the index’s movement as Stock B, regardless of the number of outstanding shares each company possesses.
This approach was one of the earliest developed techniques for creating a market indicator and offers a simple method for tracking overall market direction. Its significance lies in its historical context, offering a rudimentary view of how market values were initially understood. However, this approach can be easily distorted by stock splits or changes in a stock’s price unrelated to the company’s actual value, necessitating frequent divisor adjustments to maintain the index’s continuity.
