As you may know, the Nifty 50 and Sensex are India’s widely followed stock market indexes. Similarly, we have S&P 500, Nasdaq 100, and Nikkei 225 as stock market indexes widely followed by investors globally.
So, what are stock market indexes, how are their values calculated, and why are they considered reliable barometers to measure the economic growth of a country? Let’s understand.
A stock market index is a statistical indicator that shows all the changes happening in a particular segment of the stock market or market as a whole. It portrays the stock market’s condition, whether in an uptrend or downtrend.
The performance of the stock market indexes is used to measure the pulse of any economy. A rising stock market index indicates a healthy and growing economy.
The origins of modern stock market indexes can be traced back to July 3, 1884, when Charles Dow published the world’s first stock index- Dow Jones Transportation Index, which included 11 transportation stocks. Since then, each country has established its own stock market indexes, which primarily reflect the state of the broader economy.
Some of the oldest stock market indexes include Nikkei 225, founded in 1950 for the Tokyo Stock Exchange. S&P 500 index, established in 1957, includes 500 of the largest companies listed in the United States. Hang Seng was founded in 1969 to monitor the stock price movement of specified companies in Hong Kong.
The BSE Sensex is India’s first stock market index, established on January 1, 1986, and widely followed globally. The Nifty 50 was established on April 21, 1997, and has become the country’s most significant financial product.
How are Stock Market Indexes Created?
Stock market indexes are created by grouping equity stocks based on specific characteristics such as free-float market capitalization, industry segment, etc. For example, the Sensex includes stocks from the top 30 companies in India. In contrast, Nifty50 consists of the top 50 in terms of free-float market capitalization that are actively traded and cover all the economy’s key industries.
The weightage of each stock in the index is determined based on the specific characteristics of the stock market index. For example, Reliance Industries has a weightage of 14% in Sensex, while HDFC Bank’s weightage is 9.56%. The weights are assigned based on the company’s free-float market capitalization or other metrics.
Therefore, based on the market performance of the stock on a particular day, the index rises or falls. If the stock with the highest weight falls sharply in price, the index will also fall rapidly compared to a stock with a low weight experiencing a crash. In essence, the weight of each stock in the index determines the relative impact on the overall performance of the index.
How are Stocks Selected in the Nifty 50:
Nifty 50 rebalances its index twice yearly, with cutoff dates as January 31 and July 31. During the rebalancing process, a stock may be replaced with another, or its weightage may be changed. For a stock to be included in the Nifty 50 index, the stock must fulfill the following eligibility criteria:
- The stock must be an Indian company listed and traded in NSE
- The stock must be highly liquid, and the average impact cost of trading should be less than 0.50% during the last six months for 90% of the observation days.
- The stock must be traded in the Futures & Options segment
- The stock must be listed for a minimum of six months
How is the Stock Market Index Value Calculated?
Stock market indexes value is calculated based on the following formula:
Current Index Value = (Free Float Market Capitalization / Base Market Capitalization) * Base Index Value
Free float market capitalization: A stock’s market capitalization is calculated by multiplying the total number of shares by the per-share value. However, not all shares are available in the open market for trading. For example, let’s say the promoter’s shares, which are not traded in the market. It would be a false representation of the market capitalization for index consideration.
So, SEBI introduced the concept of free-float market capitalization in which shares available for trading in the stock market are considered for index calculation. This concept helped to remove those companies that have a small equity base. The formula for free-float market capitalization is:
Free-float Market Capitalization: Per Share Price * (Total No. of Shares – No. of Shares with Promoters)
Base Market Capitalization: It is the index’s base year market capitalization, meaning the index’s market capitalization when it was created.
Base Index Value: It is the value at which the index started its journey. For instance, the Nifty 50 base index value is 1000.
- Broader Index
- Sectoral Index
- Market Cap Index
Broader Index: Also known as a broad-based index, this index tracks the performance of a large group of stocks representing the overall stock market. It also serves as a benchmark when comparing the performance of an investment portfolio to the overall market. Nifty 50, BSE Sensex, and Nasdaq 100 are some examples of the broader indexes.
Sectoral Index: As the name implies, this index includes stocks from a specific sector or industry, allowing investors to monitor the sector’s performance and compare a stock’s performance to the particular industry. Nifty Bank, Nifty IT, and Nifty Auto are some examples of the sectoral indexes.
Market Cap Index: The market capitalization index provides market data or performance for a specific group of companies meeting certain market capitalization criteria. For example, the large-cap index includes companies with a market capitalization of more than ₹20,000 crores. In comparison, the mid-cap index comprises companies with a market capitalization ranging from ₹5,000 crores to ₹20,000 crores. The Nifty Mid-cap and Nifty Small Cap indexes are popular market capitalization-based indices.
As previously stated, stock market indexes reflect the pulse of any economy and how well it performs compared to other economies. Growing profits and healthy stock market, returns indicate positive economic growth because corporate profits are directly related to the country’s progress.
The following are more reasons why we need stock market indexes:
Reflects Investors’ Sentiment (Fear and Greed): A stock market index helps check the market’s general direction and investors’ sentiment. A market comprises thousands of stocks, but a few extensive stocks can affect the momentum of the overall market.
So, when the levels of critical indices like Nifty 50 and BSE Sensex go below their 100 or 200-day moving average, it indicates investors are doubtful of the short-term positive returns from the market in short to medium term. But, if the index is moving above this average, it’s a sign that investors are optimistic about the underlying market conditions.
Helps to Select the Right Stocks: Stock indices serve as a reference point for measuring the performance of a stock, how well it has performed against the index, and making appropriate selections. Whether the investment portfolio outperforms the index by providing higher returns or how your investment portfolio performs when the index underperforms.
Helps in Passive Investing Strategy: Index investing has become a popular investment option for millions worldwide. Investing in stocks included in the index according to the stock weights helps to mirror the index’s returns in the investment portfolio and build wealth over time while minimizing the efforts required to do stock research and costs.
Some of the most followed Indian stock market indexes are:
As previously stated, the Nifty 50 index has emerged as India’s most prominent financial product, as one can invest in it through Exchange Traded Funds (ETFs) or trade Nifty50 futures and options on the NSE and SGX. The Nifty50 F&O contracts are the most actively traded in the world.
Nifty50 consists of 50 stocks from 14 sectors. The following are the top 10 constituents of Nifty 50 by index weight as of April 28, 2023:
|Stocks||Weightage (in %)|
|Larsen & Toubro Ltd.||3.60|
|Kotak Mahindra Bank Ltd.||3.59|
|Axis Bank Ltd.||2.97|
The index, also known as the Bank Nifty, comprises most liquid and large-cap banks. Like Nifty 50, Bank Nifty is also one of the largest financial products in India. Its derivatives contracts and ETFs are widely traded at NSE.
In September 2003, Nifty Bank was established. The index consists of 12 Indian banking stocks listed on the NSE as of April 28, 2023, which are as follows:
|Stocks||Weightage (in %)|
|Kotak Mahindra Bank||10.50|
|State Bank of India||10.47|
|Bank of Baroda||2.91|
|AU Small Finance Bank||2.65|
|IDFC First Bank||1.59|
|Punjab National Bank||1.29|
Nifty PSU Bank Index is also widely tracked, including stocks of leading public sector banks in India. The top three constituents of the index are the State Bank of India, the Bank of Baroda, and the Punjab National Bank.
The Nifty Next 50 index includes stocks from the Nifty 100 index after excluding Nifty 50 stocks. The index was introduced on January 1, 1997, representing approximately 12% of NSE-listed stocks’ free-float market capitalization.
It includes stocks from 17 sectors, with the Financial, FMCG, and Capital Goods sectors accounting for nearly 42% of the index. The top ten index constituents as of April 28, 2023, are as follows:
|Stocks||Weightage (in %)|
|Bharat Electronics Ltd.||3.37|
|Bank of Baroda||3.18|
|Cholamandalam Investment and Finance||3.13|
|Godrej Consumer Products Ltd.||3.13|
In the same way that the tech-heavy Nasdaq 100 is the most closely followed index for judging the price direction of technology stocks globally, Nifty IT is closely followed in India for monitoring the overall movement of IT stocks in India.
The Nifty IT index is made up of ten NSE-listed IT stocks, which are as follows:
|Stocks||Weightage (in %)|
|Persistent Systems Ltd.||4.72|
|L&T Technology Services Ltd.||2.05|
Sensex is a benchmark index of 30 renowned and financially robust companies spanning 13 major sectors. As of May 23, 2023, the financial sector holds the highest weightage at 42.22%, followed by the IT sector at 14.92% and the Oil & Gas sector at 12%.
The following are the top 10 constituents of Sensex by index weight:
|Larsen & Toubro Ltd.|
|Kotak Mahindra Bank Ltd.|
|Axis Bank Ltd.|
In addition to sectoral indexes, the BSE and NSE have thematic indexes that cover metal, energy, housing, manufacturing, defense, and all other key sectors of the economy. Similarly, you can find market indexes for the debt market that broadly cover all types of debt papers listed on the market, such as G-Sec, Corporate Bonds, Municipal Bonds, and so on.
Stock market indexes play a critical role in identifying the next emerging sector and assisting in the efficient deployment of capital to earn higher returns.
What are stock market indexes?
Stock market indexes are a group of stocks that represents a particular segment of the market or market as a whole, showcasing how the stock market is performing over a period of time.
What are the types of stock market indexes?
There are broadly three types of stock market indexes: broader index, sectoral index, and market-cap index.
What are the stock market indexes in India?
BSE Sensex and Nifty 50 are two widely tracked stock market indexes in India.
I’m Archana R. Chettiar, an experienced content creator with
an affinity for writing on personal finance and other financial content. I
love to write on equity investing, retirement, managing money, and more.