What Is Market Cap Weighting and Why Should You Care?

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This is quite a time to observe the market. 

Let’s dive right into it. 

First off, let’s define market capitalization. That’s a company’s share price multiplied by the number of shares outstanding. 

The market cap of an index is the market cap of all the companies in that index added together. Market cap weighting a stock index means the following: making the average price movement in an index reflect which companies represent a larger portion of the market capitalization in the entire index. 

Let’s say Apple’s  (AAPL) - Get Report market cap represents 5% of the S&P 500. Let’s say another company, a smaller one, represents 0.3% of the index. If, hypothetically, all stocks on the index move 1% in a day and Apple moves 5%, the index’s move up will be higher than 1%. 

Here’s why this matters right now. 

The market sell-off this year was idiscriminate. All sectors were hit. And all sectors have risen since the market’s multi-year low hit on March 23. But then there were a few weeks when the S&P 500 was rising slightly, but most stocks weren’t. That’s because Facebook  (FB) - Get Report, Amazon  (AMZN) - Get Report, Apple, Netflix  (NFLX) - Get Report, Google  (GOOGL) - Get Report and Microsoft  (MSFT) - Get Report, which combine for a market cap of roughly $5 trillion, had all risen hugely and accounted for 20% of the S&P 500. 

So when the market continued a little bit higher, but many stocks were falling slightly, it was really that 20% of the index was rising. On an equal-weighted basis, the S&P 500, in that time, was down slightly, but the actual move was saved by big tech. 

The point for you the investor: always look at which sectors you think are better positioned than others. That way, your portfolio won’t mimic the moves of a broad index encapsulating a lot of dynamics. 

To see how to use this to your advantage in the market, watch the quick video above. 

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