What is Weighted

Weighted is a description of adjustments to a figure to reflect different proportions or "weights" of components that make up that figure. A weighted average, for example, takes into account the proportional relevance of each component instead of measuring each individual component equally. The Dow Jones Industrial Average (DJIA) is a price-weighted average that compares each security based on the stock's price relative to the sum of all the stocks' prices. The S&P 500 Index and Nasdaq Composite Index, on the other hand, are based on market capitalization, where each company is measured relative to its market value.

Where the DJIA and Nasdaq indexes utilize weighting in their calculation to more closely approximate the effect that changing stock prices will have on the overall market, weighting can also be used to help evaluate the past and current prices of individual instruments through technical analysis.

BREAKING DOWN Weighted

Emphasis can be placed on the more pertinent data through weighting; this method is used frequently in the investing and accounting world. A weighted moving average, for example, places additional emphasis on the most recent data, thereby providing a better view of current market activity. Similarly, a weighted alpha measures how much a stock has risen or fallen over a certain period, placing more emphasis on recent activity. Since more focus is placed on the current period, the calculation provides a more relevant measure for short-term analysis. Other weighted metrics include weighted average cost of capital (WACC), weighted average coupon, and time weighted average annual rate of return.

Paying Attention to Index Weights

Passive investing, or index investing, has many cheerleaders. Investing in an index is held out as the "best" way to participate in the stock market. For many investors who do not have the time, aptitude or inclination to follow the stock market, this may be true. For others, though, who care about balance in an index, periodic checks of sector weightings are useful. The S&P 500 Index, the most common market index upon which several passive investment vehicles are formed, can become overweighted in certain sectors such as information technology if the market caps of these constituents grow disproportionately relative to the other sectors. If an investor is uncomfortable with too much weight in a particular sector, an index fund may not be the right choice.