All About Stock Market Indices

All About Stock Market Indices

"23 per cent of Indian men aged between 15 and 49 are obese." – National Family Health Survey

We read statistics like this all the time. Have you wondered how that comes about? And more importantly, how is this related to stock market indices? When organisations conduct research, they don't survey the entire population to come to this conclusion. Instead, they use an appropriate sample relevant to their study. The results are considered statistically appropriate. 

Similarly, when you want to understand how the financial markets in a country are performing, it may be difficult to study all the companies listed on the stock markets. After all, more than 7,000 companies are listed on the NSE and BSE alone. Therefore, market participants or investors use stock market indices to track performance and get market insights. 

What Are Stock Market Indices? 

A stock market index is a statistical measurement of stock market fluctuations. In other words, it is an indicator of a market or a section of the market's performance. For instance, if you want to understand how the banks in India are performing, you could look at the Nifty Bank index. While it doesn't include all the banking stocks, it is a benchmark index that gives you a fair picture of their performance in the country. 

A stock market index is created using equities that meet specific criteria. The criteria could be market capitalisation, industry, size, revenue, etc. The total value of the stocks is combined to arrive at the value of the index. Any changes in the value are used to understand changes in that segment, ultimately indicating a change in the market. 

Types of Stock Market Indices 

A stock market index can be categorized into one of four types: 

1. Benchmark Index
A benchmark index is a group of securities that best represents the performance of stocks in the whole stock market. They are considered reliable sources of information to understand the position of a country's stock markets. For instance, the S&P 500 is considered America's benchmark index, while India's benchmark indices are S&P BSE Sensex and NSE Nifty. 

2. Sectoral Index
A sectoral index represents the performance of stocks in a particular sector or industry. They include stocks belonging to a specific sector, such as banking or healthcare. For instance, the Nifty Healthcare index includes 20 tradeable stocks of companies from the healthcare sector. 

3. Market Cap Index 
Market capitalisation refers to the total value of a company's outstanding common shares. Indices created based on companies' market capitalization are called market cap indices. For example, the NSE Small Cap 50 is a market cap index. 

4. Other Indices 
Other broader indices may consist of more stocks to give a better picture of the stock market. For example, the BSE 100 is a broad-based index that comprises the top 100 most liquid stocks on the Bombay Stock Exchange. 

SENSEX and NIFTY

If you trade in the Indian stock markets, you must have heard of the SENSEX and NIFTY. These are India's two benchmark indices. 

1. BSE SENSEX 
The BSE SENSEX comprises 30 of the biggest and most-traded stocks on the Bombay Stock Exchange. The word SENSEX is a portmanteau of the words Sensitive and Index. It was first published in 1986 and is often considered the pulse of Indian stock markets. 

2. NIFTY 50
The NIFTY 50 is the weighted average of the top 50 companies listed on the National Stock Exchange. It covers 13 industries in India. The NIFTY 50 was established in 1996 and has grown to become one of the major market indices of the country. 

How is the Value of a Stock Market Index Determined? 

The value of an index is usually based on the stock price of the companies included in the index. However, since each stock will have a different price and market capitalisation, simply adding the value of stock prices will not work. Instead, every stock is weighted according to its position in the index. Index values can be calculated using market cap weightage or price weightage. 

An index using market-cap weightage will give stocks weightage depending on its market cap in comparison to the total market cap of the index. For instance, if stock A has a market cap of Rs. 1,000 while the index has a total market cap of Rs. 1,00,000, its weightage will be 1%. If stock B has a market cap of Rs. 10,000, its weightage will be 10%. 

For price-weighted indices, companies are assigned weights depending on their stock prices. Stocks with higher prices will be assigned a higher weightage in the index. The Nikkei 225 in Japan is an example of a price-weighted index. 

Why Do We Need Stock Market Indices? 

A stock market index provides vital information about a country's performance. Based on the information from a stock market index, investors can decide which companies they want to invest in. 

1.    A stock market index is a near-accurate representation of a country's stock market health.
2.    It acts as a benchmark for investors to determine how their investment portfolio is performing. 
3.    It is a reflection of investor sentiment. 
4.    It makes it possible to mimic the performance of an index. For instance, investors can invest in a NIFTY index fund and earn returns equal to the NIFTY performance. 

Final Word 

A stock market index can be handy in understanding how a country's economy functions. A healthy stock market indicates that a country's production and money distribution is doing well. For investors, stock market indices help make investment decisions. You can also choose to invest in indices to enable passive investing. As an investor just starting in equity investing, it will be helpful to understand how the major indices in the country function to get important market insights.