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What’s In A Stock Market Index?

What’s In A Stock Market Index?

Stock markets make headlines every day and form a large part of dinner table conversations. But at some point, we’re all guilty of zoning out when someone mentions Nifty and Sensex. What exactly do they mean by – Nifty is up by 100 points or Sensex is down? Nifty & Sensex are nothing but market indicators to give investors an idea about how the markets are performing. Don’t let such jargon intimidate you, trust me it’s NOT as complicated as you might think. It will only take you less than 3 minutes to understand, so read on.

What is a stock market index?

Our stock markets have over 1000 companies listed on them but to track each one company to understand how markets are performing can be tough. That’s why there are stock market indices (singular-index) made up of a few selected companies to give an investor a general taste of the markets.

The index could be made up of some of the best-listed companies across different sectors, it could be made up of stocks from one sector only, or it could be made up of companies of a particular size. Once the companies are selected to form the index, its value is calculated using a complex math formula that takes into account the current share price of all the companies in it. So, if the share price of one of these companies falls, the index value will also fall.

Benchmark Indices

India has two major stock exchanges the NSE-National Stock Exchange and the BSE -Bombay Stock Exchange. Most trading happens on these. 

Nifty: This is NSE’s benchmark index. 50 stocks listed on the NSE covering 13 sectors of our economy make up this index.
Sensex: This is BSE’s benchmark index. 30 stocks of the largest and most actively traded companies listed on the BSE make up this index.

Both of these are India’s benchmark indices because they give a general idea of the Indian stock markets.

What does this mean?

When someone says markets are up they are talking about markets in terms of a benchmark index such as Nifty & Sensex. Now just because these indices are green or up doesn’t necessarily mean all companies listed on the stock market are up or doing well. The idea is to help investors decide if it’s the right time to enter the markets or not.

You know how when people say most toppers come from this college and so it’s the best in this city, here toppers are used as an ‘indicator’ to judge a college, this doesn’t mean all students from that college get the best marks. Think of a college like the stock market and ‘toppers’ like the index.

Why are they important to investors?

Indices will help you pick stocks of companies. There are over 1000 companies listed on the stock exchange and studying each is impractical. So you can use an index to help you narrow down on the ones worth investing. There are different types of indices based on characteristics of companies, for instance, an index based on the size of the company, an index based on a sector or an index based on the industry type. Using these different indices you can sort through the companies and pick stocks of the good ones. Indices also help investors understand the mood of the market and compare their own stocks to the index to know if they’re doing well or not. Two commonly used indices by the Indian economy are Nifty and Sensex. They’re the benchmark indices and people talk about markets in context to them. So when people say markets are ‘up’ or ‘down’, by markets they mean Nifty or Sensex. Nifty is an index for stocks listed on NSE-National Stock Exchange & Sensex is made up of stocks listed on BSE-Bombay stock exchange.  Both these indices are made up of stocks of some of the largest companies across many sectors (example-Reliance, HDFC,) So if Reliance’s share price falls the entire index will also fall. Lastly investors can also invest on the same stocks that form an index. This saves them the time and money on researching which stocks to buy. By simply picking stocks that form the index and investing in them an investor can build a portfolio of stocks. This is called as passive investing and their returns will mimic the returns of the index. So if the Sensex is up by 100 points their portfolio will also be up by that much.

How do they affect you?

 Whether you’re investing in the markets or not, in some way or the other you’re tied to it –

Your pension fund invests in the stock markets so any movement in the markets can directly affect your retirement money. Then, indices are also an indicator of how the economy is doing. So if a benchmark index like Nifty or Sensex is down it means the companies that form it are also down. And since some of our country’s largest companies form these benchmark indices when they’re down it probably means smaller companies are also down, similar to a storm if the big boats can’t survive the smaller ones would definitely sink. When the economy is down it means jobs are at stake, your savings are at stake, even your expenses are affected. In short, markets are important and you’re a part of it whether you like it or not!

Apart from Nifty & Sensex there are other indices too:

Sectoral Indices like BSE Bankex & CNX IT: These give us an idea of how a particular sector is performing. Example: BSE Bankex is made up of stocks from the banking sector and it tells us how the banking sector is performing on the B.S.E. And CNX IT is made up of large IT stocks traded on the N.S.E  and will tell us how the IT sector is performing on the N.S.E.

Market Capitalization based indices like the 
B.S.E. Smallcap & B.S.E. Midcap tells us about the performance of small-cap stocks i.e. small sized companies on the B.S.E and mid-cap stocks i.e. mid-sized companies on the B.S.E. respectively.

Broad-market indices like BSE 100 & BSE 500: BSE 100 is designed to measure the performance of the top 100 large-cap companies in India that are listed on BSE. And BSE 500 is designed to measure the performance of the top 500 companies listed on BSE, covering all major industries in the Indian economy. Its just a broader version of Nifty & Sensex.

Market Capitalization

A company’s value calculated by multiplying its current stock price with the total number of equity shares held by its shareholders (called as outstanding shares).  Example: XYZ has 8,000,000 outstanding shares and its current share price is Rs.8. Company XYZ’s market capitalisation=  Rs 64 million. (8,000,000 shares * Rs 8).

That was all about indices, if you still have any questions on indices, ask us in the comments section below and MissManage will manage it for you. 

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