Stock market indexes indicate a specific collection of shares chosen based on specific characteristics such as trading frequency, share size, and so on. The sampling technique is used in the stock market to depict market direction and change through an index.
Meaning of Stock Market Index
A stock market index - it is a statistical source that measures financial market fluctuations. The indices are performance indicators that indicate the performance of a certain market segment or the market as a whole.
A stock market index is constructed by choosing equities from similar companies or those that match a predetermined set of criteria. These shares are already listed on the exchange and traded. Share market indexes can be built using a range of variables, including industry, segment, or market capitalization.
Each stock market index tracks the price movement and performance of the stocks that comprise the index. This simply means that the success of any stock market index is precisely proportionate to the performance of the index's constituent stocks. In layman's words, if the prices of the stocks in an index rise, the index as a whole rises as well.
Types of Stock Market Indices
a) Sectoral Index
Both the BSE and the NSE have some strong indicators that gauge companies in a given sector. Indices like the S&P BSE Healthcare and NSE Pharma are known to be good indicators of changes in the pharmaceutical sector. Another notable example is the S&P BSE PSU and Nifty PSU Bank Indices, which are indices of all listed public sector banks. However, neither exchange is required to have equivalent indexes for all industries, yet this is a key cause in general.
b) Benchmark Index
The Nifty 50 index, which consists of the top 50 best-performing equities, and the BSE Sensex index, which consists of the top 30 best-performing stocks, are indicators of the NSE and the Bombay Stock Exchange, respectively. This group of equities is known as a benchmark index since they employ the best standards to regulate the companies they select. As a result, they are regarded as the most reliable source of information about how markets work in general.
c) Market Cap Index
Few indices select companies on the basis of their market capitalization. Market capitalization refers to the stock exchange market value of any publicly traded corporation. Indices such as the S&P BSE and NSE small cap 50 are companies with a lower market capitalization as defined by the Securities Exchange Board of India (SEBI).
d) Other Kinds of Indices
Several additional indices, such as the S&P BSE 500, NSE 100, and S&P BSE 100, are slightly larger and have a greater number of stocks listed on them. You may have a low-risk appetite, but Sensex stocks may have a high-risk appetite. Investment portfolios are not designed to fulfil all demands. As a result, investors must remain focused and invest in areas where they feel secure.
Formation of an Index
A stock market index is formed by combining equities with similar market capitalizations, business sizes, or industries. The index is thereafter computed based on the stock pick. However, each stock will have a distinct price, and the price range in one stock will not be the same as the price range in another. As a result, the index value cannot be determined by simply adding the prices of all the stocks.
As a result, allocating weights to stocks enters the picture. Each stock in the index is given a certain weightage depending on its current market price or market capitalization. The weight defines the impact of stock price fluctuations on the index value. The two most widely used stock market indices are:
a) Market Cap Weightage
Market capitalization refers to a company's overall market value on the stock exchange. It is computed by multiplying the total number of outstanding stocks issued by the corporation by the stock price. However, for a market-cap-weighted index, the stocks are chosen based on their market capitalization relative to the overall market capitalization of the index.
Assume a stock has a market capitalization of Rs. 100,000, and the underlying index has a total market capitalization of Rs. 2,000,000.
As a result, the stock will be given a weightage of 50%. An investor should keep in mind that the market capitalization of a company changes every day with the change in its price, and as a result, the weightage of the stock changes daily. In India, several indices use free-float market capitalization. The total number of shares listed by corporations is not used to determine market capitalization in this case. Instead, they use the number of publicly traded shares.
b) Price Weightage
The index value is calculated utilizing market capitalization rather than the company's stock price in this technique. As a result, equities with higher prices receive more substantial weightage in the index than stocks with lower prices.
