What is the stock market index?

Investment instruments and horizons are evolving in India. People are actively seeking ways to manage and grow their investments. In the wake of it, stock markets are gaining momentum in India. This momentum has the potential to drive businesses and the overall economic progress of the country. There are nearly 19.7 crore registered investors on the National Stock Exchange (NSE) as of September 17, 2024. 

We usually denote the stock market growth and other prospects by their index. However, people are usually curious about what is a stock market index, how it is made, its multiple types, etc. Let’s address all such questions and explore more about the stock market indices in this blog.

What is the stock market index?

A basket or a portfolio of multiple company’s stocks can be regarded as a stock market index. They usually represent a particular stock market, sector or category of the stocks. Therefore, they do not constitute all the stocks of that segment, but have a limited number of stocks. 

Multiple indexes are known as indices. Methods and calculations for its construction can differ. Some constitute stocks based on their market capitalisation, free-float weightage, specific fundamentals, revenue, sector, etc. Tracking price movements and performance of stock market index helps investors understand the market sentiment and confidence in the economy.

Importance of stock market index

• Categorisation

It is difficult for investors to navigate the large sea of listed companies. Moreover, searching for preferred stock can be time-consuming, and investors may lose a potential market opportunity. The stock market index helps in addressing this issue. It makes several categories based on different market factors. Therefore, stock search can be facilitated with these categories. 

• Benchmark for comparison

Usually, evaluating a company’s performance can be confusing if there is no reference point. The stock market index helps in providing this reference and setting a benchmark for comparing performance. 

For example, a stock from the Information Technology (IT) sector in India shows growth of 20% in a year. However, the Nifty IT index experienced growth of nearly 30% for a similar time frame as of September 19. 2024. The stock can be said as under-performing the index.

• Collective analysis

A country’s stock market performance is evaluated based on its key indices. Moreover, the stock market is a key component of an economy and indicates many elements such as demand, supply, investor confidence, money supply, specific sectoral details, etc. Therefore, a collective analysis is possible due to the stock market index.

• Passive investment instruments

The importance of stock market index is experienced when an investment is based on that sector. There are several market instruments which passively follow an index, its allocation, movement, etc. For example, sectoral mutual funds invest based on the composition of the stock market index of that specific sector.

Must read: Mutual Funds vs Stocks: Pros & Cons

Types of stock market index

Stock market indices in India are categorised as follows:

• Broad market indices: As the name suggests, they do not focus on any specific sector or strategy. However, they represent the collective state of NSE stock.
• Sectoral indices: These indices focus on specific businesses and services. They represent the market conditions for the same.
• Thematic indices: There can be stocks of companies with different businesses, but they follow a theme or have a similar characteristic.
• Strategy indices: There are different quantitative models and strategies in the market. This index includes such strategy groups.
• Other indices: It is a miscellaneous group that includes various stock market indices that are made based on different rationales or for target investors.

Stock market indices in India

• Nifty 50 

The index has wide acceptance in the country owing to its clear categorisation of the top 50 stocks on the NSE. These stocks are categorised based on their free-float market capitalisation. It has stocks from sectors like financial services, information and technology, oil gas and consumable fuels, automobile, healthcare, etc. In this index, the market cap of each company will be divided by the base price, and cumulatively, a Nifty 50 index price will be obtained. Investors cannot invest in the index directly. However, they can:

• Invest in the component companies of the index
• Invest in its Exchange Traded Funds (ETFs)
• Take positions in its derivatives market
• Invest through index funds

Do you know this? Nifty BeES: ETF with Returns of Top 50 Stocks

• BSE SENSEX

This includes the top 30 companies from the BSE 100 index based on their free-float market capitalisation. The average of six months adjusted market cap is considered for its formation. Due to free-flat, companies with higher market cap may have a high impact on the overall index. It is one of the oldest indexes in the country and has a significant impact on the overall stock markets in India. Investors can invest in BSE SENSEX by the following ways:

• Invest in its component stocks
• Take position in its derivatives trade
• Invest in index funds with their benchmark

(There are other market indices in the country. However, based on the leading stock exchanges, NSE and BSE, these two are explained.)

Famous stock market indices in the world

In the globalised world, the list of famous stock market indices is quite long. Here are some of the following:

• S&P 500 – It is used as the abbreviation for  Standards and Poor’s 500 Index. The index includes the top 500 large-cap listed companies in the United States of America. This broad range of the index makes it quite significant for consideration. 
• FTSE 100 – The Financial Times Stock Exchange 100 is one the most famous stock indexes in the United Kingdom. As the name suggests, it includes 100 highly blue-chip (large-cap) companies listed on the London Stock Exchange. 
• Hang Seng Index – It is one of the leading Asian indexes. It hails from Hong Kong. Listed on the Hong Kong Exchange (HEX), it segregates companies into 4 sectors: finance, utilities, properties and commerce and textile industries. 
• Nikkei 225 – The index includes 225 listed companies on the Tokyo Stock Exchange. It constitutes companies based on their stock’s market price. Started in 1950, the index is one of the leading indices in Asia.

An interesting read: The world’s top 10 stock exchanges by market cap: What you need to know

Bottomline

Stock market indexes are representations of multiple stocks in a bucket based on varied factors such as sector, theme, market capitalisation, etc. Understanding the importance of stock market indexes can help investors evaluate the performance of their portfolio and overall market. There are several types of indices, evolved as per investor’s dynamic requirements. In India, Nifty 50 and BSE SENSEX are some of the most prominent indices. There

FAQs

Q1. What do you mean by index in the stock market?

The stock market index refers to a group of different stocks based on their market capitalisation, sector, etc. Every stock market in the world has a separate list of indices. These can be calculated based on revenue, market capitalisation, free-float weightage, etc. They provide benchmarks for the evaluation of stock performance.

Q2. What is the importance of a stock market index?

Stock market indices are usually seen as the representation of overall market performance. Moreover, there can be large data on stocks in the market. However, the stock market index helps segregate them into different groups to identify as per investor’s needs. It also provides a benchmark for evaluating a stock’s performance or investing in index/sector mutual funds.

Q3. How stock market indices are benchmarks?

The stock market index groups stocks based on different market and business factors. It is usually used as a benchmark to compare individual stock performance or a country’s stock market performance. Actively replicating an index’s composition can be tough for an individual, so it also helps provide benchmarks for passive investment instruments like index or sector mutual funds. 

Q4. How can I invest in Nifty 50?

Nifty 50 is one of the most sought-after indices in India. It is usually considered while gauging the movement of stock markets. It is a diverse mix of stock from different sectors based on top market cap. Investors can purchase stocks from constituting this index, take a position in its derivatives, invest indirectly through index funds or buy its ETFs.