Decoding Stock Market Indices

If we were to ask you to give us a real-time summary of the traffic situation in your city, how would you possibly do it? You wouldn’t check every road in the city to find the answer, would you? The wiser thing for you to do would be to quickly check a few important roads and junctions across the city’s four directions and observe how the traffic is moving.

Similarly, if we were to ask you how the stock market is moving today, how would you answer the question? There are approximately 5,000 listed companies on the Bombay Stock Exchange and about 2,000 listed companies on the National Stock Exchange. It would be clumsy to check every company, figure out if they are up or down for the day, and then give a detailed answer.

Instead, you would just check a few important companies across key industrial sectors. If a majority of these companies are moving up, you would say markets are up, if the majority is down, you would say markets are down, and if there is a mixed trend, you would say markets are sideways!

So essentially identify a few companies to represent the broader markets. Every time someone asks you how the markets are doing, you would just check the general trend of these selected stocks and then answer. These companies that you have identified collectively make up the stock market index!

Luckily you need not actually track these selected companies individually to get a sense of how the markets are doing. The important companies are pre-packaged and continuously monitored to give you this information. This pre-packaged market information tool is called the ‘Market Index’.

An ideal index gives us minute by minute reading about how the market participants perceive the future. The movements in the Index reflect the changing expectations of the market participants. When the index goes up, it is because the market participants think the future will be better. The index drops if the market participants perceive the future pessimistically.

A stock market index combines several stocks to create one aggregate value that investors use for measuring a market’s (eg: Bombay Stock Exchange and National Stock Exchange), or a sector’s (eg: energy, infrastructure, real estate) performance. 

There are two main market indices in India. The S&P BSE Sensex representing the Bombay stock exchange and CNX Nifty representing the National Stock exchange.

S&P BSE SENSEX (also called BSE 30 or SENSEX)

S&P stands for Standard and Poor’s, a global credit rating agency. S&P has the technical expertise in constructing the index which they have licensed to the BSE. Hence the index also carries the S&P tag.

SENSEX (or SENSITIVE INDEX) was created in 1986 and is the oldest stock market index for equities. It comprises shares of 30 well-established and financially sound companies listed on BSE. These companies represent various industrial sectors of the Indian economy.

Calculation of SENSEX

SENSEX has adopted the market capitalization weighted method in which weights are assigned according to the size of the company. Larger the size, the higher the weightage.

Now, the total value of market shares at the time of the creation of the index is assumed to be100 points. This is for the purpose of logically representing the change in terms of %. So, if the market capitalization moves up 10%, the index also moves10% to 10.

Now, let’s look at the following example

S&P CNX NIFTY (also called NIFTY 50 or NIFTY)

CNX Nifty consists of the largest and most frequently traded stocks within the National Stock Exchange. It is maintained by India Index Services & Products Limited (IISL), a joint venture of the National Stock Exchange and CRISIL. In fact, the term ‘CNX’ stands for CRISIL and NSE. NIFTY was created in 1996 and comprises of 50 shares listed on the National Stock Exchange. It covers 24 sectors of the Indian economy and offers investors exposure to the Indian market in a single portfolio.

Calculation of NIFTY

Sector-specific indices

While the Sensex and Nifty represent the broader markets, certain indices represent specific sectors. These are called the sectoral indices. For example, the Bank Nifty on NSE represents the mood specific to the banking industry. The CNX IT on NSE represents the behaviour of all the IT stocks in the stock markets. Both BSE and NSE have sector-specific indexes.  The construction and maintenance of these indices are similar to the other major indices.  

Practical uses of the Index

Summing up…

Stock market indices are not just an added advantage but a necessity. In their absence, the investment world would have been mayhem of investors flocking around for good stocks to invest in. The importance of stock market indices rests in making investment easy. Having indices reduces your load and makes at least the first step in stock market investment easy.