Every day we hear people speaking that the ‘market’ fell one day, or that the ‘market’ jumped. However, if you read the stock table, you will realize that not all stocks rose or fell. There were some which moved in the opposite direction. Then, what does this ‘market’ mean?

It means an index.

WHAT IS INDEX?

An index is an indicator or measure of something, and in finance, it typically refers to a statistical measure of change in a securities market. In the case of financial markets, stock, and bond market indices consist of a hypothetical portfolio of securities representing a particular market or a segment of it.

The values of this grouped stocks are used to calculate the value of the index (typically a weighted average). Any change in the price of the stocks leads to a change in the index value. An index is thus indicative of the changes in the market and used by investors and financial managers to describe the market and to compare the return on specific investments.

HOW ARE INDICES FORMED?

To create an index, a few similar kinds of stocks are chosen from amongst the securities already listed on the exchange and grouped together.

The criteria of stock selection could be the type of industry, market capitalisation or the size of the company. The value of the stock market index is computed using values of the underlying stocks. Any change taking place in the underlying stock prices impact the overall value of the index. If the prices of most of the underlying securities rise, then the index will rise and vice-versa.

In this way, a stock index reflects overall market sentiment and direction of price movements of products in the financial, commodities or any other markets.

The two most common methods of forming indices are:

Market capitalization Weighted Index

The stock market is broadly divided on basis of market capitalization as among large cap, mid cap, and small cap. The Market capitalization refers to the total market value of the stock of a company. It is calculated by multiplying the total number of outstanding stocks floated by the company with the share price of a stock. It, therefore, considers both the price as well as the size of the stock. In an index which uses market-cap weightage, the stocks are assigned weightage based on their market capitalization as compared to the total market capitalization of the index.

The point to remember is that market capitalization changes every day as the stock price fluctuates. For this reason, a stock’s weightage too changes every day. However, it is usually a marginal change. Also, the market capitalization-weightage method gives more importance to companies with higher m-caps.

In India, free-float market capitalization is used by most of the indices. Here, the total number of shares listed by a company is not used to compute market capitalization. Instead, use only the amount of shares available for trading publicly. Consequently, it gives a smaller number than the market capitalization.

Price weightage

In this method, an index value is calculated on the basis of the company’s stock price, and not market capitalization. Stocks with higher prices have greater weightages in the index than stocks with lower prices. The Dow Jones Industrial Average in the US and the Nikkei 225 in Japan are examples of price-weighted indices.

There are also other kinds of weightages like equal-value weightage or fundamental weightage. However, they are rarely used by public indices.

IMPORTANT INDICES IN INDIA

Some of the notable indices in India are as follows:

  1. Benchmark indices like NSE Nifty and BSE Sensex
  2. Broad-based indices like Nifty 50 and BSE 100
  3. Indices based on market capitalization like the BSE Small cap and BSE Midcap
  4. Sectoral indices like Nifty FMCG Index and CNX IT

DIFFERENT INDEX THAT THE INVESTORS SHOULD FOLLOW

Broad Market Indices

The Broad-market indices consisting of the large and liquid stocks listed on the Exchange. They serve as a benchmark for measuring the performance of the stocks or portfolios such as mutual fund investments.

The two important indices in this category are

The Bombay Stock Exchange (BSE) (Sensex)

The BSE SENSEX (S&P Bombay Stock Exchange Sensitive Index), also-called the BSE 30 or simply the SENSEX, is a free float market weighted stock market index of 30 well established and financially sound companies listed on Bombay Stock Exchange. The 30 component companies which are some of the largest and most actively traded stocks, are representative of various industrial of the Indian economy. Sensex is the stock market index indicator for the BSE. It was first published in 1986.

Calculation

The calculation of Sensex is done by a Free-Float method that came into existence from September 1, 2003. The level of Sensex is a direct indication of the performance of 30 stocks in the market. The free-float method considers the proportion of the shares that can be readily traded in the market. This does not include the ones held by various shareholders and promoters or other locked-in shares not available in the market.

First, the market capitalization is considered. This is done by multiplying all the shares issued by the company with the price of its stock. Then BSE determines a Free-float factor that is a multiple of the market capitalization of the company. This helps in determining the free-float market capitalization based on the details submitted by the company. Then, Ratio and Proportion are used based on the base index of 100. This helps to determine the Sensex.

National Stock Exchange (NSE) (Nifty)

The NIFTY 50 index is National Stock Exchange of India’s benchmark stock market index for Indian equity market. Nifty is owned and managed by India Index service & products (IISL). The NIFTY 50 covers 13 sectors of the Indian economy and offers investment managers exposure to the Indian market in one portfolio.

Nifty is the market indicator of NSE. It ideally is a collection of 50 stocks but presently has 51 listed in it. It is also referred to as Nifty 50 and CNX Nifty by some as it is owned.

Calculation

Nifty is also calculated through the free-float market capitalization weighted method. Just like Sensex, Nifty also follows a mathematical formula based to know the market capitalization. It multiples the Equity capital with a price to derive the market capitalization. To determine the Free-float market capitalization, equity capital is multiplied by a price which is further multiplied with IWF, which is the factor for determining the number of shares available for trading freely in the market. The Index is determined daily by taking into consideration the current market value divided by base market capital and then multiplied by the Base Index Value of 1000.

Sectoral Indices

The Market Sector Indices summarizes the performance of stocks grouped by specific market sectors. This allows investors to benchmark the performance of a particular sector or industry.

Some important Sectoral Indices are as follows

Nifty Auto Index: The Nifty Auto Index is designed to reflect the behaviour and performance of the Automobiles sector which includes manufacturer of cars & motorcycles, heavy vehicles, auto ancillaries, tyres, etc. The Nifty Auto Index comprises of 15 stocks that are listed on the National Stock Exchange.

Nifty Bank Index: Nifty Bank Index is an index comprised of the most liquid and large capitalized Indian Banking stocks. It provides investors and market intermediaries with a benchmark that captures the capital market performance of Indian Banks. The index has 12 stocks from the banking sector which trade on the National Stock Exchange.

Nifty Financial Services Index: The Nifty Financial Services Index is designed to reflect the behaviour and performance of the Indian financial market which includes banks, financial institutions and housing finance and other financial services companies. The Nifty Finance Index comprises of 15 stocks that are listed on the National Stock Exchange (NSE).

Nifty FMCG Index: FMCGs (Fast Moving Consumer Goods) are those goods and products, which are non-durable, mass consumption products and available off the shelf. The Nifty FMCG Index comprises of maximum of 15 companies who manufacture such products which are listed on the National Stock Exchange (NSE).

Nifty Pharma Index: Pharmaceuticals sector is one of the key sectors where Indian companies have created a global brand for themselves besides software. Indian companies have taken advantage of the opportunities in the regulated generics market in the western countries and made deep inroads especially in providing low cost equivalents of expensive drugs. Pharma outsourcing into India and low-cost Healthcare services are expected to be the key areas of growth in the near future. In addition, the inherent potential of biotechnology has also attracted many new companies, and this is also a key growth area for Indian companies. IISL has developed Nifty Pharma Index to capture the performance of the companies in this sector.

Nifty IT Index: Information Technology (IT) industry has played a major role in the Indian economy. In order to have a good benchmark of the Indian IT sector, IISL has developed the Nifty IT sector index. Nifty IT provides investors and market intermediaries with an appropriate benchmark that captures the performance of the IT segment of the market. Companies in this index are those that have more than 50% of their turnover from IT related activities like IT Infrastructure, IT Education and Software Training , Telecommunication Services and Networking Infrastructure, Software Development, Hardware Manufacturer’s, Vending, Support and Maintenance.

Ranjith

Dilzer Consultants Pvt Ltd

Reference:

https://www.investoo.com/the-importance-of-stock-market-indices/

http://www.mistakesintrading.com/wiki-stocks/importance-of-stock-market-indexes.php

https://www.myaccountingcourse.com/accounting-dictionary/stock-index

https://www.quora.com/What-is-a-stock-market-index

https://www.fool.com/knowledge-center/what-is-a-stock-index.aspx

https://www.investopedia.com/terms/i/index.asp