You might have heard about the recent launch of indices by NSE. What is the significance of these indices & other indices in the stock market? We are going to answer all these in this blog. Keep on reading to know more!
Stock Market Index
A stock market index is a measure that shows changes taking place in the stock market. Stock Market Index shows the overall trends of the capital markets and sentiments of investors towards a particular stock in an industry. It also shows the direction of price movements of products in the financial, commodities, or any other markets. In India, NSE Nifty, BSE Sensex, Nifty 50 are some popular stock market indices. Whereas, Dow Jones is a popular stock market index in the USA. Similar stocks are chosen from the securities already listed on the exchange and grouped to form an Index. The criteria of stock selection can be one of the following:
The type of industry
The size of the company
The value of the stock market index is calculated using the values of the underlying stocks. Any change taking place in the underlying stock prices affects the overall value of the index. When prices of most of the underlying securities increase, then the index value also increases and vice-versa.
Following are the most significant indices in the Indian stock market:
Benchmark indices like NSE Nifty and BSE Sensex
Broad-based indices like Nifty 50 and BSE 100
Indices based on market capitalization like the BSE SmallCap and BSE MidCap
Sectoral indices like the Nifty FMCG Index and CNX IT
Use of stock market Indices
The stock market indices act like a forecast which shows the overall conditions of the market. They make it easy for investors to identify the general pattern of the market. Investors take the INDEX as a reference to decide which stocks to go for investing.
In a stock exchange, there are thousands of listed companies. Because of this, selecting the right stock and sorting them could be a challenge. Therefore, a benchmark has come into existence. With the help of this benchmark, it becomes easy to differentiate between the stocks. It classifies the companies and their shares based on characteristics like the size of the company, sector, industry type, and so on.
Indices represent the trend of the whole market or a certain sector of the market. In India, the NSE Nifty and the BSE Sensex act as the benchmark indices. They indicate the performance of the entire stock market.
Before including stock in your portfolio, you have to evaluate whether it is worth the money. By comparing with the underlying index, you can determine the performance of a stock. If the stock gives higher returns than the index, it is said to have outperformed the index and, if it gives lower returns than the index, it is said to have underperformed the index.
You can also compare the index with a set of stocks. As an investor, you can know market trends.
While trading in equity markets knowing investor sentiment becomes an important thing because the sentiment affects the demand for a stock which in turn impacts the overall price. To invest in the right stock, you should know the reason behind the rise or fall in its price. At this point, indices help to ascertain the mood of investors. You can also recognize investor sentiment for a specific sector and across market capitalization.
Passive investment refers to investing in a portfolio of securities that replicate the stocks of an index. Investors who want to reduce the cost of research and stock selection prefer to invest in index portfolios. Accordingly, the returns of the portfolio will be similar to that of the index. If an investor’s portfolio is similar to the Sensex, then his portfolio will deliver returns of around 9% when Sensex earns a 9% return.
How are Stock market indices formed?
An index is formed with similar stocks based on market capitalization, industry, or company size. After the selection of stocks, the index value is computed. Each stock will have a different price and price change in one stock would not be proportionately equal to the price change in another. So, the value of the index value cannot be obtained just by simply summing the prices of all the stocks.
Therefore it becomes important to assign weights to stocks. Each stock in the index is given a particular weightage based on its market capitalization or price. The weight shows the impact that the stock’s price change has on the value of the index.
Most commonly used Indices
Market Cap Weightage:
Market capitalization is the total market value of a company. It is calculated by multiplying a company’s total number of stocks by the share price of the stock. Therefore, it considers the price as well as the size of the stock. In an index that uses market-cap weightage, the stocks are assigned weightage based on their market capitalization as compared to the total market capitalization of the index. In India, free-float market capitalization is used by most indices. Here, the total number of shares listed by a company is not used to calculate market capitalization. Instead, uses only the amount of shares available for trading publicly. Therefore it gives a smaller number than the market capitalization.
In this method, the value of an index is calculated based on the stock price of a company rather than the market capitalization. Thus, the stocks which have higher prices get higher weightage in the index as compared to the stocks which have lower prices.
Newly added Indices by NSE
NSE’s index services subsidiary, NSE Indices Limited, launched two new sector indices namely, Nifty Consumer Durables and Nifty Oil & Gas today to track the performance of stocks from the Consumer Durables and Oil & Gas industries. Each index consists of the top 15 companies from their respective industries within the Nifty 500 index. The stocks are selected based on their average free-float market capitalization.
Nifty Consumer Durables - NIFTY CONSR DURBL
Nifty Oil & Gas - NIFTY OIL AND GAS
NSE also added,
Nifty Healthcare Index - NIFTY HEALTHCARE
Nifty LargeMidcap 250 - NIFTY LARGEMID250
Nifty500 Multicap 50:25:25 - NIFTY500 MULTI CAP