Introducing stock market indices

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Stock market indices: an overview

Say it’s New Year’s Eve and you’re sitting with a bunch of your friends. After a lot of pleasant banter, somebody eventually pops the obvious question, “So, how was your year?”

How would you answer that? After all, it’s not easy to gauge each of the 365 days in the past year, isn’t it? Instead, you’re more likely to quickly whiz through the bygone year in your head and revisit the important things that happened to quickly assess what kind of a year you had.

Got a promotion, bought a new house and took that vacation of your dreams? Well, in that case, you’ll perhaps tell your friend that you had a fabulous year.

On the flip side, if you lost someone close to you, or had to move to a new place you didn’t really like, you wouldn’t call your year so great.

So, essentially, the important events helped you assess how the year went, isn’t it?

Similarly, moving on to the stock markets, let’s consider this question: “How is the stock market behaving today?” 

You see, there are thousands of stocks listed on the NSE and the BSE. Clearly, it’s impossible to track the movement of the shares of each listed company. A better approach would be to quickly look at the top few companies on the exchange and track their movements.

If the shares of most of the top companies are on an upward trend, you’d conclude that the markets were performing well that day. If, on the other hand, they’re moving downward, you’d say the markets were performing poorly. These top companies that you just picked, they’re what make up the major stock market indices. 

So, what is an index in the stock market?

Stock market indices are indicators that reflect the performance of the market as a whole or of a certain segment of the market. 

A stock market index consists of a group of companies whose shares are traded on an exchange. Each index measures the price movement and the performance of the shares of its constituent companies. This effectively means that the performance of the index is directly proportional to the performance of the stocks in the index. To put it simply, when the prices of the stocks in an index go up, that index, as a whole, also goes up. 

Okay then. We’ve now cleared up the answer to the question - What is an index? Let’s get to know more about how indices are constructed. They each consist of a specific number of stocks (such as 30 or 50 or 100). And they include only the most well-established and financially strong companies across various industries and sectors. This makes indices a fairly accurate representation of the state of a country’s economy.     

The two benchmark indices in the Indian stock market

In India’s financial market, there are primarily two main indices: 

  1. The S&P BSE SENSEX
  2. The CNX NIFTY. 

These two are commonly known as broad market indices. Let’s delve a little deeper to get a more thorough understanding.   

S&P BSE SENSEX

Introduced in 1986, the SENSEX is India’s oldest index. It represents a group of companies listed in the Bombay Stock Exchange (BSE). Here are some facts about BSE SENSEX. 

  • Standard and Poor’s (S&P), an international credit rating agency, licensed its technical expertise to BSE to construct the index. 
  • Therefore, the index is always referred to along with the S&P tag.
  • The SENSEX comprises the top 30 largest and most frequently traded stocks within the Bombay Stock Exchange.  

CNX NIFTY (NIFTY 50)

What is NIFTY 50? Also known as the CNX NIFTY, this index, which was first established in 1996, is the National Stock Exchange’s (NSE) answer to the SENSEX. This index, known also as the NIFTY 50, is a representative of a group of companies listed in the NSE. Let’s take a brief look at some facts about the CNX NIFTY. 

  • The NIFTY is owned and maintained by India Index Services & Products Limited (IISL). 
  • The IISL is a joint-venture organisation between an Indian credit rating agency CRISIL and the National Stock Exchange.
  • As a matter of fact, the CNX tag in the CNX NIFTY stands for CRISIL and NSE.
  • The NIFTY’s constituents consist of the top 50 of the largest and most frequently traded stocks within the NSE. 

Other sector-specific indices

Since the SENSEX and the NIFTY cover multiple sectors of the economy, they are considered to be broad market indices. However, both the BSE and the NSE also have sector-wise indices that track the performance of particular sectors or industries. These sectoral indices are also constructed in the same manner as broad market indices. 

For instance, BANK NIFTY is a sectoral index that tracks the performance of the top 12 stocks from India’s banking sector. Similarly, BSE AUTO is another sector-specific index that reflects the performance of the automotive industry and consists of the top 15 stocks from that sector.   

How are stock market indices beneficial to investors?

The performance of market indices is a fairly accurate indicator of the state of the economy and of the general investors’ sentiments. Stock market indices also provide investors like you with a wealth of information. You can then make use of this information to formulate your investment strategy. 

Here’s a brief glimpse at how indices are beneficial to investors. 

They provide important information for benchmarking

As we’ve already seen, the movement and performance of indices tend to be a true indicator of the overall trend of the stock markets. For instance, when the indices are going up, the general consensus is that the investors and market participants are optimistic. 

That’s not all. Many traders, investors and other market participants also use the performance of the indices as a benchmark for analysing how their investments performed in the stock market. 

For example, you can use the performance of an index like NIFTY for a certain time period and compare that with the actual performance of your investment portfolio for the same time period. This way, you would get a more accurate and relevant representation of the performance of investments.  

They help reduce your exposure to risk

As an investor, your main goal is to outperform the market. One way to do that is by investing in indices via index funds, rather than in a single stock or a set portfolio of stocks. Since indices contain stocks from a wide range of sectors and industries, the risk of underperformance is lowered because of diversification. 

When you invest in a single stock, your capital might get eroded if that stock doesn’t perform according to your expectations. However, with stock market indices, the chance of all of its constituents going down at the same time is very slim. Therefore, your exposure to risk is minimised to a large extent. 

Wrapping up

With this, our chapter on stock market indices comes to a close. So, now, if you’re ever questioned about “what is an index” or “what is NIFTY 50,” you’re well-equipped to answer those queries. In the upcoming chapter, we’ll get into the details of what goes on in the front end of the stock markets.

A quick recap  

  • Stock market indices are indicators that reflect the performance of the market as a whole or of a certain segment of the market. 
  • A stock market index consists of a group of companies whose shares are traded on an exchange. 
  • Each index measures the price movement and the performance of the shares of its constituent companies. 
  • In India’s financial market, there are primarily two main indices: the S&P BSE SENSEX and the CNX NIFTY. 
  • The SENSEX comprises the top 30 largest and most frequently traded stocks within the Bombay Stock Exchange. 
  • The NIFTY’s constituents consist of the top 50 of the largest and most frequently traded stocks within the NSE. 
  • Both the BSE and the NSE also have sector-wise indices that track the performance of particular sectors or industries.
  • Indices provide important information for benchmarking and help reduce your exposure to risk.
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