An equity index represents a basket of stocks that track the performance of a specific sector, industry, or market. Led by market leaders like the S&P 500, the importance and popularity of equity indices are only increasing among investors worldwide.
Methodology of Creating an Equity Index
An equity index measures the performance of a subset of stocks in a market. It's created by selecting certain stocks representing a market, sector, or industry and calculating their combined weightings based on a chosen methodology.
Market Capitalization Method
This approach considers the total value of the company and assigns a higher weight to stocks with more market capitalization. For example, the S&P 500 takes this approach.
Equal Weighted Method
This approach assigns the same weight to each stock in an index. However, it does not account for differences in market capitalization or the number of outstanding shares of each stock.
Price Weighted Method
This approach assigns more weight to stocks that have a higher price per share. The Dow Jones Industrial Average uses this approach.
This approach considers factor characteristics like size, momentum or volatility, etc. to build an index.
Importance of Equity Index
Equity indices are essential for investors. They indicate the stock market's health, allowing for trend tracking and informed decisions. They provide a benchmark for comparing individual stock performance, diversifying portfolios, and showing economic changes through business cycles.
Equity indices offer diversification to investors. Instead of investing in a single stock, they invest in a basket of stocks and track their performance.
Equity indices act as a benchmark for equity fund returns and provide a common point of comparison for investment performance.
Investors can easily gain exposure to a variety of markets or sectors through index funds or exchange-traded funds (ETFs).
Types of Equity Indices
There are several types of equity indices, each designed to track the performance of different segments of the stock market. Some of the most common types include:
Tracks the performance of large-cap stocks, typically defined as stocks with market capitalization greater than $10 billion. This is as per US capital market. In India large cap companies are those that have market capitalization of Rs 20,000 crore or more.
Mid Cap Index
The Mid Cap Index tracks the performance of mid-sized companies, which typically have market capitalization between $2 billion and $10 billion. In India, mid cap companies are defined that have market capitalization between 5,000 crores and Rs 20,000 crores.
Small Cap Index
Tracks the performance of small-cap stocks, typically defined as stocks with market capitalization less than $2 billion. In India, small cap companies are those that have market capitalization below Rs 5,000 crores.
Tracks the performance of stocks in a particular sector, like technology or healthcare.
Tracks the performance of stocks with similar characteristics, such as value or growth stocks.
Tracks the performance of foreign companies, offering opportunities for global diversification and exposure to different markets.
Equity Indices in India
BSE and NSE are indices measuring the Indian stock market's performance. BSE tracks 30 top companies since 1875, while NSE tracks the top 50 companies since 1992. They indicate Indian economy's well-being and guide investors' choices, affected by government policies, politics, and global economy.
Tracks the performance of the top 50 stocks listed on the National Stock Exchange (NSE).
Tracks the performance of the top 30 stocks on the Bombay Stock Exchange (BSE).
The Bank Nifty Index is a popular benchmark stock market index that represents the banking sector in India. Essentially, it reflects the performance of the largest, most liquid banking stocks listed on the National Stock Exchange (NSE) in India.
Tracks the top 100, top 200, and top 500 stocks listed on the BSE.
India has several equity indices, including BSE 500, BSE Midcap, BSE Smallcap, Nifty Midcap, Nifty Smallcap, and sector-specific indices like Nifty Bank, Nifty IT, Nifty Pharma, Nifty FMCG, and Nifty Auto. These indices give investors and traders a comprehensive view of the Indian stock market, with the India VIX measuring volatility expectations over the next 30 days.
Major Global Equity Indices
Major global equity indices track stock market performance in different countries. Examples include S&P 500 (US), FTSE 100 (UK), Nikkei 225 (Japan), and DAX (Germany). Investors use these indices to measure regional or country-level performance and assess global economic health.
Important US Equity Indices
Dow Jones Industrial Average
Tracks the performance of 30 large, publicly traded companies in the US, representing various sectors of the economy.
Tracks the performance of more than 3,000 companies listed on the NASDAQ stock exchange, with a focus on technology and growth stocks.
Tracks the performance of 2,000 small-cap companies in the US, providing insight into the overall health of the domestic economy
Important European Equity Indices
Tracks the performance of the 100 largest companies listed on the London Stock Exchange, providing insight into the overall health of the UK economy.
Tracks the performance of the 30 largest companies listed on the Frankfurt Stock Exchange, providing insight into the overall health of the German economy.
EURO STOXX 50
Tracks the performance of the 50 largest companies in the Eurozone, providing insight into the overall health of the European economy.
Important Asian Equity Indices
Tracks the performance of 225 large, publicly traded companies on the Tokyo Stock Exchange, providing insight into the overall health of the Japanese economy.
Hang Seng Index
Tracks the performance of 50 of the largest companies on the Hong Kong Stock Exchange, providing insight into the overall health of the Hong Kong economy.
Tracks the performance of all stocks traded on the Shanghai Stock Exchange, providing insight into the overall health of the Chinese economy.
How to Invest in Equity Indices?
Investing in equity indices is easy. First, choose an index or group of indices. Second, select an investment vehicle like an ETF or mutual fund that tracks those indices. Check the track record fees, and remember to diversify. Investors can also directly buy baskets of stocks that match the index portfolio. To invest in equity indices, choose an index, open a brokerage account, decide on investment strategy, place your order, and monitor your investment for long-term gains. They are low-cost, low-risk investments offering a simple, transparent, and efficient way to build wealth over time.