A stock market index abbreviated as a stock index is an indicator that shows all the major changes in India's stock market.
The same stocks are selected from amongst the securities already grouped and listed on the stock exchange to develop an index. However, the selection criteria are based upon the type of industry, the company's size, and its market capitalization.
This indicator is used to minimize the mess up and indicate the proper position of the market. Changes in the price of underlying assets impact the overall value of the index.
If the price goes upwards, the stock index will rise, and if they go downwards, the stock will fall.
There are three different types of stock market indices mentioned below:
1) Benchmark Indices
2) Sectoral Indices
3) Market-Cap Based Indices
Nifty 50 – a collection of top 50 best-performing stocks and BSE Sensex – a collection of top 30 best-performing stocks are indictors of the National Stock Exchange and Bombay Stock Exchange, respectively.
This collection of stocks are known as benchmark indices respectively because they use the best practices to regulate the companies they pick.
Hence they are known as the best point of reference for the working of markets in general.
Both BSE and NSE have some good indicators that measure companies falling under one specific sector.
Indices like S&P BSE Healthcare and NSE Pharma are considered good indicators of their respective changes in the pharmaceutical sector.
Another prominent example could be S&P BSE PSU, and Nifty PSU Bank Indices are indicators of all the listed public sector banks.
However, both the exchanges don't have to have corresponding indices for all the sectors, but this is generally a significant cause.
Few indices choose companies based on their market capitalization. Market capitalization means the market value of any public traded company in the stock exchange.
Indices like S&P BSE and NSE small cap 50 are a collection of companies that have a lower market capitalization in accordance with the rules set by the Security Exchange Board of India (SEBI).
Several other indices like S&P BSE 500, NSE 100, S&P BSE 100, among others, are slightly larger indices and come with a more significant number of stocks listed on them.
You may have a low-risk appetite and stock listed on Sensex may have a high-risk appetite. Investment portfolio are not tailored to meet every needs. So investor has to be focused and invest in which they feels safe.
A stock market index is created by adding similar stocks based on their market capitalization, company size or industry. Later on, the index is computed based on the selection of stocks.
However, each stock will come with a different price and price change in one stock would not be equal to the price range in another stock.
Hence, the index value cannot be decided based on the simple sum of the prices of all the stocks.
Due to this, assigning weights to stocks comes into the picture. Each stock in the index is assigned a specific weightage based on its price lying in the market or because of its market capitalization.
The weight defines the impact that changes in the stock price has on the index value. There are two most commonly used stock market indices are:
Market capitalization refers to the total market value of a company in the stock exchange. It is calculated by multiplying the total number of outstanding stocks floated by the company and the share price of a stock.
However, the stocks are selected based on the market capitalization compared to the total market capitalization of the index for an index that uses market-cap weightage.
Suppose a stock has a market capitalization of Rs. 100,000, whereas the underlying index has a total market cap of Rs. 2,00,000. Thus, the weightage given to the stock will be 50%.
An investor must keep in mind that the market capitalization of a stock keeps on changing every day with the change in its price, and because of this reason, the weightage of the stock keeps changing daily.
Several indices in India use Free-float market capitalization. Here the total shares listed by companies are not used to calculate market capitalization.
Instead, they use the number of shares available to trade publicly.
In this method, the index value is measured based on the market capitalization rather than measuring on the stock price of the company.
Thus, the higher prices of the stocks receive more significant weightage in the index as compared to the stocks which have lower prices.
There are three different types of stock market indices mentioned below:
1) Benchmark Indices
2) Sectoral Indices
3) Market-Cap Based Indices
A stock market index is created by adding similar stocks based on their market capitalization, company size or industry. Later on, the index is computed based on the selection of stocks.
A stock market index abbreviated as a stock index is an indicator that shows all the major changes in India's stock market. The same stocks are selected from amongst the securities already grouped and listed on the stock exchange to develop an index. However, the selection criteria are based upon the type of industry, the company's size, and its market capitalization.
Final Thoughts
Stock market indices are considered not just an advantage but also a necessity. The importance of stock market indices helps companies to make their investment safer and more accessible.
Having indices reduces the investors' pressure and guides them through the first step in making stock market investment easy.
That’s not all, an investor has to understand a lot when it comes to investing. We all know Sensex has top 30 companies, but it does not mean that these 30 are best for your investment.