What Are Stock Market Index/Indices?
Stock market indices represent a certain group of shares selected based on particular criteria like trading frequency, share size, etc. The stock market uses the sampling technique to represent the market direction and change through an index.
To help you understand this concept further, let’s begin with the most basic question, what is a stock market index?
Stock Market Index Meaning
A stock market index is a statistical tool that reflects the changes in the financial markets. The indices are indicators that reflect the performance of a certain segment of the market or the market as a whole.
A stock market index is created by selecting certain stocks of similar companies or those that meet a set of predetermined criteria. These shares are already listed and traded on the exchange. Share market indices can be created based on a variety of selection criteria, such as industry, segment, or market capitalization, among others.
Each share market index measures the price movement and the performance of the shares that constitute that index. This essentially means that the performance of any stock market index is directly proportional to the performance of the underlying stocks that make up the index. In simpler terms, if the prices of the stocks in an index goes up, that index, as a whole, also goes up.
What Are The Types Of Stock Market Indices?
There are different types of stock market indices based on the kind of stocks taken into account to create the index. Here’s a closer look at some of the most common types of indices:
- Benchmark indices such as BSE Sensex and NSE Nifty
- Broader indices such as Nifty 50 and BSE 100
- Indices created based on the market capitalization of companies, such as BSE Midcap and BSE Smallcap
- Sector-specific indices like Nifty FMCG, Nifty Bank Index, CNX IT, and S&P BSE Oil and Gas
A Closer Look At The Two Benchmark Indices In The Indian Stock Market
India’s stock markets have two benchmark indices - BSE Sensex and NSE Nifty.
S&P BSE Sensex:
Sensex is a blend of the words sensitive and index. It was introduced in 1986 and is the oldest in India. The BSE Sensex consists of the top 30 largest and most frequently traded stocks listed in the Bombay Stock Exchange (BSE).
CNX NIFTY (NIFTY 50):
Also known as the NSE Nifty, this share market index consists of the top 50 largest and most frequently traded stocks within the NSE. First created in 1996, NSE NIFTY is owned and maintained by India Index Services & Products Limited (IISL), which is a joint-venture organization between an Indian credit rating agency CRISIL and the National Stock Exchange. The CNX portion in the CNX NIFTY stands for CRISIL and NSE.
Why Are Stock Market Indices Required?
The performance of market indices acts as a nearly accurate indicator of the state of the markets and reflects the general sentiments of investors. These indices also provide investors with a wealth of information that helps them create and implement investment strategies.
Provide Important Information For Benchmarking:
Many traders, investors and other market participants use the performance of the indices as a benchmark for analyzing their investments in the stock market. For instance, you can use the performance of NIFTY over a given period to compare it with the actual performance of the stocks in your investment portfolio during that period.
Help Minimize Your Exposure To Risk:
One way to outperform the market is by investing in index funds. The risk of underperformance is low in index funds because they contain stocks from several sectors and industries, thereby essentially diversifying your investment portfolio. When you invest in specific stocks, your corpus might be eroded if those stocks don’t perform well. With stock market indices, however, your risk exposure is largely reduced.
Help Passive Investors:
Picking the right stocks to invest in requires a great deal of research. This may be impractical for passive investors, who are looking for avenues to invest in over the long term without constantly monitoring their portfolio actively.
Stock market indices are extremely useful and act as a cushion for conservative investors in times of market volatility. If you’re a beginner in the equity markets, it may be a good idea to start by learning about share market indices and testing the waters to get a better idea of how the markets work in practice. You could also create a portfolio that replicates a stock market index with IIFL today. It will reduce the costs of research and stock picking without compromising on the quality of your investments through expert recommendations and an investment plan curated especially according to your risk appetite.