What is an Index? What is Nifty and Sensex?
You may have often heard news channels speak about Nifty50 or Sensex. Monitoring both of these helps investors and the general public analyse the stock market's direction and a country's economic conditions. In this article, we will discuss what a stock market index is and what Nifty50 and Sensex are.
What is an Index?
An index simply means an indicator, sign, or measure of something. It is a number that measures or indicates something. A stock market index is used to measure the performance a specific group of stocks or stocks belonging to a particular sector. It provides a snapshot of how the overall market or a particular sector is performing. Essentially, it helps investors analyse the pulse of the stock market.
What is the Purpose of an Index?
The economic growth of a country is measured using various indicators like gross domestic product (GDP), employment rates, etc. A stock market index also acts as a barometer or indicator of an economy by reflecting the collective performance of stocks of listed companies. When an index rises, it suggests optimism, economic growth, and positive investor sentiment. On the other other, a decline may indicate caution, economic challenges, or a more pessimistic outlook.
An index provides insights into the overall health of the stock market, allowing investors, analysts, and policymakers to measure economic conditions, trends, and potential risks. As a result, it becomes a key tool for decision-making, helping people make informed choices based on the prevailing economic climate.
NSE has around 2,000 listed companies, while BSE has around 5,000 listed companies. So it’s practically impossible to look at the performance of all these stocks daily. Therefore, we use an index. This index represents the performance of the constituent stocks in the index.
What is Nifty50?
Nifty50 is the benchmark index of the National Stock Exchange (NSE). It represents the top 50 companies listed on the NSE. When Nifty50 rises, it indicates that the prices of the underlying stocks are generally increasing, and vice versa. Click here to learn more about the constituent companies.
What is Sensex?
Sensex is the benchmark index of the Bombay Stock Exchange (BSE). It represents the performance of 30 well-established and financially sound companies listed on BSE. Click here to learn more about the constituent companies.
Why are Stock Market Indices Important?
- Indices offer a quick overview of whether the market is bullish (rising) or bearish (falling).
- Investors use indices as benchmarks to evaluate the performance of their portfolios against the broader market. An investor can aim to beat the benchmark set by the index while investing for the long term.
- Indices help investors diversify their investments by offering exposure to different sectors.
- Movement in indices reflects the economic conditions and trends in specific industries.
- They provide insights into investor sentiment and confidence.
- Indices also serve as the basis for other investment products such as ETFs and Index funds.
How Are Nifty50 and Sensex Calculated?
We know that NIFTY50 comprises the top 50 companies on the NSE. The value of Nifty50 is calculated using a complex formula that involves the price of the stocks and their free-float market capitalization. In simple terms, the level of the index reflects the total market value of all the stocks included in the NIFTY 50, relative to a particular base period. NSE has fixed November 3, 1995 as the base period, which marks the completion of one year of operations of NSE's Capital Market Segment. The base value of the index has been set at 1,000, and a base capital of Rs 2.06 lakh crore.
A similar formula is applied to calculate BSE's Sensex, but it involves only the top 30 companies.
How Are These Companies Selected?
For calculating Nifty50 and Sensex, their respective exchanges have complex criteria for selecting constituent companies. The Nifty50 undergoes semi-annual rebalancing, while the Sensex is rebalanced on a monthly basis. When a company falls out of the criteria, it will be swapped out by another new company that falls within the criteria.
To learn more about how stocks are included/excluded in NIFTY50, click here.
What Are Sectoral Indices?
We saw that NIFTY50 can be used to measure the stock market performance of the Indian economy. NIFTY is calculated based on market cap, or we can say that it is a broad-based index. Similarly, indices can be made based on sectors, which are termed sectoral indices. A sectoral index represents the top companies in a specific sector such as IT, Pharma, Metal, Auto, etc. The performance of different sectors can be measures using such indices.
Nifty Pharma is a sectoral index of NSE which represents the performance of top pharmaceutical companies in the country. Similarly, there are 11 sectoral indices in the NSE that represent various sectors of the economy.
Just like NSE has various sectoral indices, BSE also has different indices that represent various sectors of the country.
In conclusion, a market index is an invaluable tool for investors in many ways, such as a benchmark for their investment portfolios and knowing the state of a country’s economy. These indexes can represent the top companies in the country, and companies in different sectors, segments, and asset classes. If used correctly, an index could be your best friend to make investment decisions.