09
Oct
Capital Weight Vs Equal Weight
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It has bothered me for quite some time, that indexes and ETFs are generally calculated in a manner different than composite data. The inescapable question was, are we comparing apples and oranges? There was only one way to find out and that was to recalculate each index and ETF using an equal weight methodology.
Although this data has been available on the site for some time now, I was not satisfied with the way it was calculated. Most methods experience some sort of “drift” over the long run. The chart looked the same, more or less, but values exhibit an upward bias (usually) over the long run winding up with values that don’t really relate to anything in the real world. Here is the example that woke me up to this problem. Buy a stock at 50. It goes up to 100, a 100% gain. It goes back down to 50, a 50% loss. Cumulative gain by this simple method is 50%. Obviously, you see the problem. Most methods seem to incorporate some degree of this “drift”. The charts look OK, but the numbers don’t relate to anything.
After much experimenting and brain searching, it occurred to me that every issue simply needed to start at a value set at a specific point in time. That makes sense, but component stocks often have different starting trade dates and I want to use their entire price history. Others were trading before our historical datafiles starting date. The answer was to set each component’s start value (the value for comparing all other price history of that component) to the stock’s price at the beginning of the current trading year. If that value became 100%, how did all other prices compare (percentage-wise) to that value? Needless to say, I wouldn’t be writing this if it did not work.
To make the values more readable and prevent them from going negative, when compiling each component’s value it starts at 100 (beginning of this year’s value). So when the equal weight chart below shows a current close value of 101.58, it means that combined equal weighted component performance is up 1.58% since the first of this year. The S&P 500 itself is down 1.32% for the year (actual values). The difference is accounted for by the differences between capital weighting and equal weighting. The components with heavier weighting are currently pulling the index down more than they would if they had an equal weight to every other component. In my opinion, that is very significant.
This calculation is performed on the price history of about 3400 stocks and then accumulated into the various recalculated indexes and ETFs using their current component lists. The method exhibits absolutely no “drift” and values remain true to real price performance. |
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Comments, criticisms and suggestions are always appreciated. I thank you for your past support and hope you continue with us. In any event, good trading. Best, Larry Carhartt MasterDATA |
