Over a year ago, Saud wrote a very informative post explaining the differences between a weighted index and a price index. A weighted index places value on shares based on their respective market capitilizations relative to the overall market capitalization of the the stock market. For example, Zain (KD 1.460 ) would have a bigger weight in the index and affects it more than Wataniya Telecom (KD 1.860). Why? Because Zain’s market capitalization stands at KD 5.7 billion vs Wataniya’s market capitalization of KD 0.9 billion. Do you know what a price index would do? It would simplistically place more value on the higher priced share. Although Zain is 6 times bigger than Wataniya, Wataniya would affect a price index more than Zain!
Yesterday something unacceptable occurred at the Kuwait SE as Tas’heelat, which is a small company that last traded a month ago, fell more than 50% yesterday from 345 fils to 160 fils. Blue chips in the Kuwait SE were trading up and the weighted index continued to reflect a positive bias even after the massive decline in Tas’heelat’s share price because the company’s market capitalization is minuscule. However, the price index instantly declined and closed down for the day. Talk about wrong signals and a failed index!
Most developed nations adopt a weighted index and the Kuwait SE must do the same for the aforementioned reasons. Some people may argue that the famous Dow Jones Industrial Index is an example of a price index that works well in the U.S., however, one has to realize that the reason it works is because it is comprised of only the 30 largest companies in the US. It doesn’t include any small companies! The Kuwait SE has to adopt the weighted index as its main index because it is very reliable, more representative of the market, and is adopted by most developed markets.
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