In finance, a stock index, or stock market index, is an index that measures a stock market, or a subset of the stock market, that helps investors compare current price levels with past prices to calculate market performance. It is computed from the prices of selected stocks.
Stock Index is used to gauge the movements of the stock markets and to see whether the stock prices in general are going up or going down one looks towards the stock market index numbers like BSE Sensex or NSE Nifty. Indices give a summary of historical price levels of the markets. One can also easily establish relationships between different sectoral Indices & certain sectors of the economy or the overall economy.
An index number is a number which measures the change in a set of values over a period of time. A stock index represents the change in value of a set of stocks which constitute the index. Precisely, a stock index number is the current relative value of a weighted average of the prices of selected stocks. It is a relative value because it is expressed relative to the weighted average of prices at some arbitrarily chosen starting date or base period.
Forex: the base year of Sensex is 1978 and NSE Nifty is 1995. The value of 1978 Sensex as base year is taken as 100 and Nifty in 1995 is taken as 1000.
- Technical Analysts make use of index by charting the price levels at various periods of time and detect patterns from it. They form the opinion on the basis of it for buying
- A well-Constructed Market Index will give an indication of the prices of the entire population under consideration. Index numbers are also used by various traders in the derivatives market.
A market Index is a convenient and effective product because it acts as a barometer for market reactions and can be used as a benchmark for fund performance. Most of the fund managers of the broader market funds attempt to beat these benchmark indices like Sensex or Nifty.
- Characteristics of Good Index:
1. It should capture the behavior of a large variety of different portfolios from different industries in the market. The index number should be, therefore, wide enough to incorporate different industries.
2. The stocks included in the index should be highly liquid with a large volume of trading.
3. It should be professionally maintained by a group of highly professional fund managers.
4. A good market index should accurately reflect the behavior of the overall market for a market index as well as the difference of index numbers. Free float Market capitalization method is portfolios of a specific group of industry.
5. A well–diversified index is more representative of the overall market sentiments.
6. An index should contain as many stocks with as little impact cost (minimum bid-offer spread) as possible.
7. An index set should be reviewed on a regular basis and sync in line with the current state of the market.
- Methods of calculating stock index
- Price weighted index
- Market capitalization weighted index
- Free Float Capitalization
2.1 Price weighted index
A price weighted index is one that gives a weight to each stock that is proportional to its stock price. A popular price-weighted stock market index is the Dow Jones Industrial Average (DJIA). It includes a price-weighted average of 30 actively traded blue chip stocks of America.
2.2 Market capitalization based index
Price weighted index is biased in favor of those companies whose share price is high even if they are small sized in terms of their equity. In a market capitalization weighted index, each stock in the index affects the index value in proportion to the market value (capitalization value) of all shares outstanding. In this type of index, the equity price is weighted by the market capitalization of the company. For example: S&P 500 and FTSE 100 are based on market capitalization methods.
2.3 Free Float Market Capitalization method
Most of the prominent indices all over the world have moved from market capitalization method to free float market capitalization method of index numbers. Free float Market capitalization method is calculated by multiplying readily available shares in the market for trading with its market price. It excludes promoter’s holding, government holding, and other locked in shares. For example All BSE index, NASDAQ 100 are free float market capitalization index numbers.
- Some Popular Indices at NSE & BSE
3.1 Standard & Poor’s CNX Nifty or simply Nifty/ Nifty 50
CNX stands for the Credit Rating Information Services of India Limited (CRISIL) and the National Stock Exchange of India (NSE).S&P CNX Nifty is a well diversified 50 stock index accounting for 22 sectors of the economy. In preceding years, indices were made out of judgment and lacked any scientific base but nowadays it is based on strong research. It not only acts as a barometer but also acts as the foundation for development of various financial new products like index futures, index options and index funds.
S&P CNX Nifty is owned and managed by India Index Services and Products Ltd. (IISL) Recently S&P CNX has moved away from NSE to join BSE for their Index Sensex. BSE Sensex is now known as S & P Sensex after S & P Dow jones tying up with BSE. S & P CNX Nifty therefore, is known as CNX Nifty Index.
3.2 CNX Defty
S&P CNX Defty is CNX Nifty, measured in dollars. It is a performance indicator to foreign institutional investors, off-shore funds, etc. It provides an effective tool for hedging Indian equity exposure. As it is measured in dollars, it provides an instrument for measuring returns in dollars for foreign investors.
3.3 S&P CNX 500
The CNX 500 is India’s first broad based benchmark of the Indian capital market. It encompasses almost all kinds of industries with a fair representation.
CNX 500 companies are disaggregated into72 industry indices viz. CNX Industry Indices. Industry weightages in the index reflect the industry weightages in the market. For e.g. if the infrastructure sector has a 5% weightage on NSE, infra stocks in the index would also have near to 5% in an index. It’s a replica of the S&P 500.
3.4 S&P Sensex
For gauging the movement of the Bombay stock exchange listed stocks, Sensex is used as a barometer. The BSE Sensex or Bombay Stock Exchange Sensitive Index comprises 30 stocks taken April 1979 as base year. It consists of the 30 largest and most actively traded stocks, representative of various sectors on the Bombay Stock Exchange. These companies account for around one-fifth of the market capitalization of the BSE.S & P Sensex is a replica of Dow Jones 30.