S&P 500 Equal-Weight Trading Strategy: Backtesting and Practical Example

In January 2003, the S&P 500 Equal Weight Index (EWI) was created, and since then, you can trade ETFs that track the index. But what does this equal weight S&P 500 index mean?

As the name implies, the EWI is an equal-weight version of the popular S&P 500 Index. But instead of weighting each stock in the index based on its market, every stock is given equal weight in the index. There are many ETFs that track the EWI through which you can invest in the index. History shows that the S&P 500 equal weight index has outperformed the S&P 500 market weight index. We make an S&P 500 equal-weight trading strategy.

Let’s take a look at the S&P 500 equal-weight index and how it is different from the traditional S&P 500 index:

What is the S&P 500 equal-weight index?

Created in 2003 by Standard & Poor’s, the S&P 500 Equal Weight index is an index of the top 500 companies in the US, but instead of weighting each company in the index based on its size — as it is with the traditional, market-cap-weighted S&P 500 index — every company is given equal weight in the index.

In other words, both S&P 500 index types have the same component stocks but the weighting formula is changed — every stock in the index has the same weight, regardless of how large or small the company is. So, even Apple, the largest stock in the US, has the same weight as the smallest company in the index.

This simple change to the weighting formula changes the results drastically — the returns are not the same. The sector weight is a direct function of the number of companies in the sector. For example, if a sector contains 45 stocks, then the weight of the sector would theoretically be (45 / 500) x 100 = 9%.

The S&P 500 is heavily tilted to the few biggest mega-caps and thus they make a huge part of the total returns.

How is it different from the S&P 500 index?

The traditional S&P 500 index is weighted by the market capitalization of the component stocks. So, stocks with the largest market capitalizations or the biggest values, have the highest weights in the index. The weight of a stock in the index is equal to the market cap of that stock divided by the total market cap of all the stocks in the index. And, the sector weight is calculated by summing up the individual weights of the companies that will make up that sector.

For the S&P 500 Equal Weight Index, on the other hand, each of the component stocks is weighted equally. While the S&P 500 EWI includes the same constituents as the market-capitalization-weighted S&P 500, each company in EWI is allocated a fixed weight — 0.2% of the index total at each quarterly rebalance.