Just like the Earth revolves around the sun, it can’t be denied that our data-driven world revolves around the metrics that serve as performance indicators. The world of the stock market is a prime example of the statement above. Price fluctuations, market size, and other variables meticulously commend the formation of major key performance indicators of the stock market, called indices. Common indices in India include BSE Sensex and Nifty 50.
What are indices?
Indices serve as a statistical tool to measure changes in the financial market. These indices act as performance metrics, reflecting how the market or a specific market segment is performing. In simpler terms, indices tell us how well a stock market segment or the stock market India, as a whole, is performing.
How is an index formed?
Calculations lie at the heart of the Indian stock market index, elucidating the fact that the formation of indices is an intricate process. Nonetheless, calculations vary among different index providers. Generally speaking, the following is the process that is followed while developing an index:
1. Choosing stocks:
A group of stocks, particularly those with a certain market capitalization, trading volume, industry size, and other variables, are chosen.
2. Adding weightage and calculating the value of the index:
At this step, the calculation for the assignment of weightage can differ between different providers. Once the stocks have been selected, weightage is assigned based on the company’s significance in the market. The significance is most commonly determined by looking at two variables:
- Stock price: Companies with higher stock prices are given more weightage. As a result, the index suffers a greater impact if companies with high share prices experience fluctuations compared to companies with lower share prices.
- Market capitalization: Companies are selected based on how big they are compared to the value of the whole index. It is computed by multiplying the total number of the company’s shares by the price of each share. When an index is formed by assigning weightage based on the market capitalization, companies with higher market share have a greater influence on the index.
3. Maintaining the index: Since stock prices are dynamic, the index is regularly reviewed and rebalanced by different index providers, like NSE India, to keep it in line with the market or sector that it tracks. It might entail adding or removing stocks, adjusting weights, or revising the index’s formula.
The significance of stock market indices:
1. Benchmarking and diversification: Stock market indices serve as a standard against which investors can assess how well their investments or mutual funds are doing. By comparing their returns to the performance of a relevant stock market index, investors can evaluate their progress.
Additionally, investors can use the information of indices to figure out stocks and what sectors they can include in their portfolio, depending on the performance potential of different stocks or sectors.
2. Market analysis: Financial analysts and traders can use stock market indices, like the Nifty Index, to identify emerging market trends. Using this information, traders can accurately forecast the growth of a certain market sector.
To conclude, market indices, such as Nifty and Sensex serve as more than just a performance indicator for different industries. For traders and financial analysts, they are of great significance as they help them forecast market trends and growth opportunities.