Market indices bring together a select group of company stocks and regularly measure them to show the performance of the overall market or a certain segment of the market.
There are thousands of companies listed on stock markets, making it almost impossible to monitor each company. This is why stock market indices are created.
In short, an index helps investors understand the health of the stock market, enables them to study the market sentiment and makes it easy to compare the performance of an individual stock.
Sensex and Nifty are the two most important stock market Indices in India. They are the benchmark indices meaning, the important ones, and a standard point of reference for the entire stock market of India.
For example, the BSE Sensex is an index consisting of 30 stocks. Similarly, the BSE 500 is an index consisting of 500 stocks.
KEY TAKEAWAYS
S&P BSE Sensex, a collection of 30 best-performing stocks, and Nifty 50, a collection of 50 best-performing stocks are indicators of BSE and NSE respectively. They are considered benchmark indices because they are the most concise, use the best practices to regulate the companies they pick, and hence are the best points of reference for how the markets are doing in general.
NSE Indices Limited (formerly known as India Index Services & Products Limited), or NSE Indices, owns and manages a portfolio of 67 indices under the NIFTY brand as of September 30, 2016, including NIFTY 50. NIFTY indices are used as benchmarks for products traded on NSE.
NIFTY indices served as the benchmark index for 38 ETFs listed in India and 12 ETFs listed abroad as of September 30, 2016. Derivatives benchmarked to NIFTY indices were also available for trading on four international stock exchanges as of November 30, 2016 (The Singapore Exchange, the Chicago Mercantile Exchange, the Taiwan Futures Exchange and the Osaka Securities Exchange).
Sensex, otherwise known as the S&P BSE Sensex index, is the benchmark index of India's BSE, formerly known as the Bombay Stock Exchange.) The Sensex is comprised of 30 of the largest and most actively traded stocks on the BSE, providing a gauge of India's economy.
Created in 1986, the Sensex is the oldest stock index in India. The index's composition is reviewed in June and December each year. Analysts and investors use it to observe the cycles of India's economy and the development and decline of particular industries.
|
Fun Fact: BSE adds S&P as a prefix before all the indices because, in the year 2013, BSE and S&P Down Jones Indices, a global resource for all index related information announced a strategic partnership “to calculate, disseminate, and license the widely followed suite of BSE indices,” BSE had said in a statement. It is just a co-branding technique. To learn how to use an index for benchmarking portfolio performance join NIWS Best share market course in Jaipur
|
Market-Cap Based Indicies
Market cap is the market value of any public traded company. There are few indices that purely select companies only on the basis of market capitalization.
Indices like NSE small cap 50 and S&P BSE small-cap are indices that are a collection of only those companies that have a lower/smaller market capitalization in accordance with rules by SEBI. There are also other indices like NSE midcap 100, S&P BSE midcap, and likewise.
Sectoral Indicies
NSE and BSE also have some indicators that are a gauge of companies falling under one particular sector. Indices like NSE Pharma and S&P BSE Healthcare are indicators of their respective exchanges for the pharmaceutical sector.
It is not necessary that both the exchanges will have corresponding indices for all the sectors but this is generally the case.
Another example could be Nifty PSU Bank and S&P BSE PSU Indices are indicators of all the listed public sector banks.
Other Indicies
There are also some other indices like S&P BSE 100, S&P BSE 500, and NSE 100 among others which are slightly bigger indices and have a much bigger number of stocks listed on them.
Till now we understood, what are stock market indices and their examples but do we know how a stock market index in India selects stocks.
When an entire index, for e.g. a Sensex or a Nifty goes up or down, it means that stocks comprising those indices have performed better or worse. This does not mean that if a company, say Reliance Industries Ltd. (RIL) which is listed in both, the Nifty and Sensex, goes up by say 5% during a trading session, the index will not correspondingly go up by 5% because there are other stocks in the index as well which may have gone up or down and influenced the movement of the index.
How will the weights be assigned depends on the stock selection strategy put in place? On any given day, not all sectors in the economy are doing well. An index’s total value cannot be a simple addition of all m-cap values because not all stocks carry the same weightage in the index
There are primarily two factors by which stocks are picked:
Companies with the largest market cap are picked and grouped together in an index when the M-cap is the premise of the stock selection strategy.
Companies with the largest m-cap have a bigger weightage on the index’s value while stocks with a small m-cap do not influence the index as much. Indian indices mostly use free-float market capitalization for assigning weights to their stocks.
There are also some indices in the world that use price to give weightage to stocks in an index.
An example of this would be Japan’s Nikkei 225. Companies with a higher stock price have a higher weightage and impact the index more than the lower valued stocks.
Note:
M-cap is the total value of the company measured in the outstanding shares it has issued. Free float m-cap, which the indices use to weigh stocks, excludes shares held by promoters.
For example, Reliance Industries Ltd. (RIL) has the highest free float m-cap as on April 20 closing data so it has the highest weightage among other stocks that form Sensex. So a movement in RIL, positive or negative, will have a higher impact than a positive or negative movement in other stocks.
The basic premise of having indices is to make trading easy for investors.
Imagine a stock market where you do not have such categories, where all the stocks listed on the exchanges are available for purchase, you do not know which stock has a higher m-cap, or lower value and which are the ‘better’ stocks. This is where the importance of stock market indices is realized.
They make it easy for you to trade by grouping them and making their visibility stronger.
Here are a few reasons why having indices is an essential component of stock market investments:
Let’s consider Sensex as an example. S&P BSE Sensex is a collection of 30 stocks, S&P BSE 100 is a collection of 100 stocks, and S&P BSE 500 is a collection of 500 stocks. These indices help you to see the top stocks by way of m-cap in one place.
For example, in current times when a pandemic has gripped the entire world and stock markets are down, you may be curious about how the health sector is doing. In the absence of indices, you would have to hunt for all pharmaceutical companies individually, collate them together, and do your own math.
However, grouped indices like Nifty Pharma and S&P BSE Healthcare do that job for you.
Indices have a plethora of information on stocks. Price history, volume changes, peer-to-peer comparison, sector performance, volatility, and a sense of where the market is moving. If a collection of the 30 or 50 best companies shows an uptrend or a downtrend, it speaks volumes about how the stock market is generally doing.
If we refer to the table above, we can see that in the calendar year 2020, the Nifty 50 has dropped 26.59% and Sensex by 26.07% in the last 4.5 months. This speaks a lot about investor sentiment.
The coronavirus has shaken investor confidence and global economies. With job loss, industry shutdowns and the lockdown imposed, people have lower confidence in the markets and do not consider them as safe havens anymore. Currently, the market is indicating a negative investor sentiment.
|
Index |
YTD performance (year to date) * |
|
Nifty 50 |
-26.59% |
|
S&P BSE Sensex |
-26.07% |
*As of April 20 closing session
An index’s value depends on whether it is a price-weighted index or a market-cap-weighted.
Below is an example of the BSE Sensex to understand how an index is calculated.
Stock market indices are the bread and butter of the investment milieu. It is not just an added advantage but a necessity.
Having indices reduces your load and makes at least the first step in stock market investment easy. This is not the end. You do need to do the rest of the work for yourself regarding investing.
Investment portfolios cannot be one-size-fits-all and need to be tailor-made for every investor.
Start with a demonstration class.