Averages are used all the time in finance, usually to justify performance (‘above average’). However, as an investor, you should realise there are several ways to calculate an average. The three most common are the mean, median and mode.
First, you can calculate the mean. Let’s say you have five FTSE 100 readings on consecutive days. They are 4,800, 4,900, 4,700, 4,800 and 5,100. The mean is the sum of the readings (24,300) divided by the number of readings (five). So that’s 4,860.
One of the problems is that extreme outliers (say one of the readings was 3,000 or 6,000) can give a misleadingly high or low figure. So you can “sense-check” this by calculating the median. This is the data point that sits in the middle when all the data are ranked in ascending order. Looking at our figures, that’s 4,800. So in this case, using the median to test the mean shows that the two are close together, indicating that the mean can be taken as representative and has not been unduly distorted by outliers.
Finally, there’s the mode – the most common reading. In this example, that’s also 4,800.