In simple terms, a stock market index is a collection of various stocks used by investors to gauge overall market performance. These indices include specific stocks that meet predetermined criteria for inclusion. Familiar terms like ‘Nifty’ and ‘Sensex’ represent popular stock market indices. Understanding indices such as Nifty and Sensex is essential for navigating the stock market effectively. Moreover, exploring advanced investment strategies like stock lending and borrowing (SLB), with stockbrokers like Share India, can further enhance one’s investment portfolio. Now, let’s delve deeper into the world of stock market indices to gain a comprehensive understanding.
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Types of Indices in the Indian Stock Market
There are three main types of stock market indices in India: benchmark indices, sector-specific stock market indices, and market-cap-based indices.
Benchmark Indices
The Nifty 50 and the Sensex referenced above are benchmark indices. A benchmark index is considered the standard to measure the performance of the entire stock market. That is why the phrase ‘a fall in the Nifty’ is synonymous with an underperforming market in India.
Sector-Specific Stock Market Indices
Sector-specific stock market indices, or sectoral indices, are indices focused on a particular sector like banking or IT. In India, some of the most popular sectoral indices include the Nifty Bank, Nifty IT, S&P BSE PSU, etc. The name itself suggests that Nifty Bank involves banking stocks, and Nifty IT involves IT stocks. Investors may refer to a sectoral index to evaluate the performance of a specific sector. For example, investors may refer to the Nifty Bank index to evaluate the performance of the banking sector as a whole.
Market-Cap-Based Indices
The third type of indices we find in the stock market is market-cap-based. The components of these indices must satisfy certain criteria based on market cap. Some market-cap-based indices include the Nifty Midcap 100, the BSE Smallcap, etc.
Need For Stock Market Indices
- Stock market indices help investors evaluate the performance of the larger market or a specific sector. To put it another way, investors may refer to stock market indices before making investing or trading decisions.
- Investors also compare the performance of their portfolios with the performance of the benchmarks, like the Nifty, over a specific period.
- Stock market indices are also used as benchmarks for index funds or passive mutual funds, which are designed to track the performance of a specific index.
Creation of Stock Market Indices
To be included in an index, the stock needs to satisfy certain criteria. For example, the stock must meet a minimum market-cap requirement or trading volume criteria or belong to a specific sector. This said, all the stocks in the index may not carry the same weight. Some stocks have a higher weightage than others, and the weight of the stock is assigned based on its market cap or price.
Price-Weighted
In this type of weightage method, the price of the stock is used to determine the weightage of the stock in the index. The Dow Jones Industrial Average (DJIA) is one of the most popular price-weighted indices in the world.
Market-Cap-Weighted
Market capitalisation, or market cap, is the total value of the company obtained by multiplying the total number of outstanding shares by the price of the stock.
- Stocks with higher market-cap hold a higher weightage in a market-cap-weighted index.
- The free-float market-cap method is a variant of the market-cap-weighted method. The variation only takes into account the number of shares that are available to trade publicly, instead of all the company’s shares.
- The companies with higher free float market-cap are given higher weightage.
- Stock market indices like the Nifty and Sensex are calculated using the free float market capitalisation method.
Understanding Sensex and Its Calculation
The Sensex, also called the S&P BSE Sensex, first computed in 1978–1979, is the benchmark index of the Bombay Stock Exchange (BSE).
- The Sensex is composed of BSE’s 30 most financially sound companies and is computed using the free-float market capitalisation-weighted methodology.
- When the Sensex was first computed in 1978–1970, its base value was 100.
- Since it’s a benchmark index, investors refer to a Sensex to evaluate the performance of the Indian stock market.
Understanding Nifty and Its Calculation
The Nifty, also called the Nifty 50, is the benchmark index of the NSE (National Stock Exchange).
- The Nifty consists of the top 50 companies listed on the NSE, and, like the Sensex, it is also computed using the free-float market capitalisation-weighted methodology.
- The Nifty is a younger index than BSE’s Sensex, as it was first calculated in 1995, starting with the base value of 1995.
- The present value of the Nifty will reflect the total market value of all the stocks in the index relative to the base year value.
- Like the Sensex, the Nifty is also used by investors to evaluate the overall market.
Conclusion
Stock market indices serve as valuable indicators for investment decisions. Whether assessing the overall market or specific sectors, indices like Nifty or Sensex offer crucial insights. For beginners, index investing is often viewed as a low-risk approach to equity investment.
