As we will know the financial markets are very intriguing and active marketplace, where investors of all size and shape participate, creation and trading of financial assets, such as shares, debentures, bonds, derivatives, currencies, etc.
These markets also play a crucial role in allocating limited resources, in the country’s economy.
In India, we have two large marketplace in operations – the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE).
Given their importance in our economy and ability to attract investors, certain fundamental rules/indicators are designed for the benefit of participants.
Among several indicators that are generated for the benefit of investor is an index, which is also known as the market barometer or benchmark.
So as we understand from the above, an index is an indicator or measure of something, and in finance, it typically refers to a statistical measure of change in a securities market. In the case of financial markets, stock, and bond market indices consist of a hypothetical portfolio of securities representing a particular market or a segment of it.
Stock market indices is a procedure of measuring certain stocks. They are used to measure the performance of the certain portfolios. The prime use of the indices is to understand the trends of the market.
NSE 50 share index or Nifty and the BSE 30 share sensitive index known as Sensex.
A stock indices is created by choosing a group of certain stocks. These stocks are able to represent the entire stock market’s trends. They may also represent a specify segment like mutual funds. The changes in the price movements are related to the base period. Their performance shows how the overall market economy or a particular industry is.
Stocks are sold and bought in Indian stock market as a group. The mix of various stocks has a number of indexes. These are used to benchmark the performance in terms of the economy. The groups are on the basis of the segment or industry. It can also be on the basis of the company size or some other. To make it clear, BSE 500 is an index of 500 stocks.
The values of these grouped stocks form the basis for calculation of the stock index values. Any up or down in the price of the indices impact the index value.
In stock indices, proper weights are given to the stocks as per their economic importance. The stock market indices are like a barometer of the market. They help the investors to identify the broad trends of the market. Investors use them before allocating the funds among the stocks. The technical analysis uses these indices to forecast the market trends. A general trend of the economy is displayed by the stock indices. Thus, indices act as a guide for the investors.
Due to many reasons, indices are important. Their ability to reflect the market scenario make them special. The major factors of the stock market indices will self-explain their importance.
Indices segment the stocks of different companies based on different factors. These give an instant sorting to the investors. Just Imagine, how you would search for them in the absence of indices.
A comparative study is easier with indices. Investors can compare certain kind of stocks against another group. This gives company wise or industry wise trends. You will know stocks of which industry are flaring better. Similarly, you will now the trend of the small sized companies. Or the performance of the giant corporate.
The stock market indices show the position of the whole market or a certain segment. The BSE Sensex and the NSE Nifty are the benchmark indices. They represent the overall market scenario or performance. For example IT stock indices represent the market performance of the stocks of IT companies.
Stock indices are calculated using two different methods. The one is a calculation on the basis of market-cap weight age. Second is on the basis of price weight age. Market-cap weight age is the total market value of a stock. It is multiplied by the total number of the shares of the company. This is also known as market capitalization. This calculation changes with the price and number of shares of a company.
Price weight age method calculates the company’s stock price only. In this case, the stocks with the higher value or price have a higher weight age.
Based on the segmentation in the indices, many investors decide their portfolio. Due to indices, invests reduce their cost of research. They are able to decide their investments easily. Indices also construct ETFs and mutual funds.
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