Understanding the Stock Market Index

What is an Index?
An index 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. More specifically, a stock index number is the current relative value of a weighted average of the prices of a pre-defined group of equities. The starting value or base of the index is usually set to a number such as 100 or 1000.  For example, the base value of the Nifty was set to 1000 on the start date of November 3, 1995. A good
stock market index is one which captures the behaviour of the overall equity market. It should represent the market, it should be well diversified and yet highly liquid. Movements of the index should represent the returns obtained by “typical” portfolios in the country.

From among the stocks listed on the exchange, some similar stocks are selected and grouped together to form an index. This classification may be on the basis of the industry the companies belong to, the size of the company, market capitalization or some other basis. For example, the BSE Sensex is an index consisting of 30 stocks. Similarly, the BSE 500 is an index consisting of 500 stocks.

Uses of Index?

a. as a barometer for market behavior,

b. as a benchmark of portfolio performance,

c. as an underlying in derivative instruments like index futures, and

d. in passive fund management by index funds

How do we interpret index movements?

They reflect the changing expectations of the stock market about future dividends of the corporate sector. The index goes up if the stock market thinks that the prospective dividends in the future will be better than previously thought. When the prospects of dividends in the future becomes pessimistic, the index drops. The ideal index gives us instant readings about how the stock market perceives the future of corporate sector.

Every stock price moves for two possible reasons:

1. News about the company (e.g. a product launch, or the closure of a factory)

2. News about the country (e.g. budget announcements)

The job of an index is to purely capture the second part, the movements of the stock market as a whole (i.e. news about the country). This is achieved by averaging. Each stock contains a mixture of two elements - stock news and index news. When we take an average of returns on many stocks, the individual stock news tends to cancel out and the only thing left is news that is common to all stocks. The news that is common to all stocks is news about the economy. That is what a good index captures. The correct method of averaging is that of taking a weighted average, giving each stock a weight proportional to its market capitalization.

Major Indices

BSE-SENSEX 30-Stock large Market Capitalisation Index

S&P CNX Nifty 50-Stock large Market Capitalisation Index

S&P CNX 500 A broad based 500 stock Index

S&P CNX Defty US $ denominated Index of S&P CNX Nifty

S&P CNX Industry indices The S&P CNX 500 is classified in 73 industry sectors. Each such sector forms an Index by itself.

CNX Nifty Junior 50-Stock Index which comprise the next rung of large and liquid stocks after S&P CNX Nifty

CNX Midcap 200 A midcap Index of 200 stocks

CNX PSE Index Public Sector Enterprises Index

CNX MNC Index Multinational Companies Index

CNX IT Index Information Technology Index

CNX FMCG Index Fast Moving Consumer Goods Index

CNX Millenium Index The new economy Index

BSE Sensex

BSE SENSEX is most popular and widely used indicator of the stock market in the country. It consists of 30 stocks comprising the largest and the most liquid stocks in India. BSE SENSEX was introduced on 1.1.1986 with base year 1978-79. The base value of Index has been set at 100.

S&P CNX Nifty

The price index of securities traded on National Stock Exchange (NSE) is reflected through NSE-50 index, popularly known as NIFTY. It comprises 50 scientifically selected scripts. It was introduced on April 22, 1996, with the base year of November 3, 1995. The base value of index has been set at 1000.