A stock exchange index captures the behavior of an overall equity market. Therefore, different indices are used as information sources. By looking at an index, one can know how the overall market is doing.
Different investors hold different portfolios of stocks. An index is a lead indicator of how the overall portfolio would perform. An index also serves as a benchmark for measuring the performance of fund managers.
Indices reflect the changing expectations of the stock market about future dividends of the corporate sector. When an index moves up, the stock market thinks that the performance of the companies comprising the index will be good. Similarly, when the market feels that the performance of companies consisting of an index might not be suitable in the future, then an index value may drop.
An index gives us instant readings about how the stock market perceives the future of a corporate sector.
The general market index is the broad-market index, consisting of the large, liquid stocks of the country.
BSE- Sensex and NSE Nifty are the most famous indices in India. Sensex is a composition of 30 stocks, whereas Nifty has 50 stocks. An industry index is used as a benchmark for comparing the returns of the stock portfolio that is related to that industry.
Important Indices in India
Benchmark indices like NSE Nifty and BSE Sensex.
- Broad-based indexes like Nifty 50 and BSE 100.
- Indices based on market capitalization like the BSE Small-cap and BSE Midcap.
- Sectoral indices like Bank Nifty, FMCG, CNX IT, etc.
NSE Nifty 50
The Nifty is the flagship benchmark of the National Stock Exchange (NSE), a well-diversified index comprising the top 50 companies in terms of free-float market capitalization that are traded on the bourse. It reflects the financial health of the top traded Indian companies and hence the broader economy in all market conditions.
Nifty Fifty is computed using the free-float market capitalization method, essentially the count of shares in active market circulation at any given time.
The Nifty index was launched on April 22, 1996, with a base value of 1,000 from November 3, 1995.
Sensex, also known as the S&P BSE Sensex index, is India’s benchmark stock market index. Sensex comprises 30 of the most extensive and actively-traded stocks on the Bombay Stock Exchange, providing an accurate gauge of India’s economy.
The index’s composition is reviewed in June and December each year. Initially compiled in 1986, the Sensex is the oldest stock index in India.
Other Important Stock Exchange Indices
CNX Nifty Junior
The next level of liquid securities after S&P CNX Nifty is the CNX Nifty Junior. S&P CNX Nifty and the CNX Nifty Junior make up India’s 100 most liquid stocks.
Stocks in the CNX Nifty Junior are filtered for liquidity, so they are the most liquid of the stocks excluded from the S&P CNX Nifty. Therefore, a stock will never appear in both indices simultaneously.
CNX 100 is computed using the market capitalization-weighted method, wherein the index level reflects the total market value of all the stocks in the index relative to a particular base period. The process also considers constituent changes in the index and, importantly, corporate actions such as stock splits, rights, etc., without affecting the index value.
S&P CNX 500
The S&P CNX 500 is India’s first broad-based benchmark of the Indian capital market for comparing portfolio returns vis-à-vis market returns. The S&P CNX 500 represents about 92.66% of total market capitalization and 86.44% of the total turnover on the NSE.
The objective of the CNX Midcap Index is to capture the movement and be a benchmark for the midcap segment of the market. CNX Midcap is computed using the market capitalization-weighted method, wherein the level of the index reflects the total market value of all the stocks in the index relative to a particular base period. The process also considers constituent changes in the index and, importantly, corporate actions such as stock splits, rights, etc., without affecting the index value.
The most common methods for calculating stock market indices are:-
Price Weighted Index
A price-weighted index is a stock market index in which the constituent securities are weighted in proportion to their stock price per share. Companies with higher stock prices significantly influence the index’s overall movement in such an index. The advantage of the price-weighted index is its simplicity. The Dow Jones Industrial Average in the USA is a prominent example of a price-weighted index.
Equal Weighted Index
An equal-weighted index is a stock market index that gives equal value to all the included stocks. In other words, each stock in the index has the same importance when determining the index’s weight, regardless of whether the company is large or small or how many shares are trading.
It’s observed that an equal-weighted index may potentially generate better or more incremental returns over time compared to a price-weighted or capitalization-weighted index.
Value Weighted Index
A value-weighted index assigns a weight to each company in the index based on its value or market capitalization. Value-weighted stock indices are currently the most popular of the three stock index weighting types. For example, the S&P 500 is a value-weighted index.
The advantage of value-weighted stock indices is that companies and industries are represented according to their market capitalization, which is a good indicator of importance in an economy and the stock market.
What are the uses of Stock Market Indices?
Stock market indexes can be helpful to follow for a few key reasons:
- First, tracking the most-followed stock market indices can give you a general sense of the health of the overall stock market.
- Tracking lesser-known indices can help you see how a particular market segment performs compared to the whole market.
- If you don’t want to invest in individual stocks but instead want to match the overall market’s performance, then a cost-effective way to earn solid returns over time is by investing in index funds that track the stock market indices you’re most interested in.
- Stock market indices make it easier to know how the market performs without following every individual stock’s ups and downs. They also open up simple investment opportunities that even novice investors can use to participate in the long-term success of the stock market.
Conclusion: Stock Exchange Index is a Barometer of Economy
A stock market index shows how investors feel an economy is performing. An index collects data from a variety of companies across industries. Together, that data forms a picture that helps investors compare current price levels with past prices to calculate market performance.
Investors and fund managers use stock indices as one of the many tools to evaluate the performance of a stock market. The application of indices is now much broader, including the use of indices as benchmarks for investor portfolio comparisons, for example, measuring the performance of Mutual Fund Schemes, Exchange Traded Funds (ETFs), and other managed portfolios schemes.