How often have you come across a headline that reads something like “90% of people in their twenties believe in getting some form of cardiovascular exercise at least thrice a week,” or “70% of working women do not have a house help at home?” These statistical figures are not absolute - they do not give you the details of every person in the age group or the demographic involved. Instead, they give you a broad idea based on a sample. This technique, called sampling, can help you make inferences and gather insights about many areas in finance, economy, society and more.
The stock market also makes use of this technique to give investors a fair idea of how the markets are moving. Here’s where stock market indices come into the picture. Also known in common parlance as share market indices, they help you gauge the overall behavior of the market.
So, to get into the details, you’ll need to look at various aspects like the stock market index meaning, the types of stock market indices, and why we need them. Let’s begin at the basics and answer the most fundamental question in the context of share market indices - What is a stock market index?
If you were to look at the stock market index meaning in the technical sense, it is a statistical tool or measure that reflects the changes occurring in the financial markets. In other words, stock market indices are indicators that reflect the performance of the market as a whole or of a certain segment of the market.
A stock market index is created by selecting certain stocks of similar companies or certain stocks that meet a set of predetermined criteria. These shares are all already listed and traded on the exchange. Share market indices can be created based on a variety of selection criteria, such as an industry, a 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 go up, that index, as a whole, also goes up. And if they plummet, so does the index.
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.
For more details read: Types of Stock Market Indices
India’s stock markets have two benchmark indices - BSE Sensex and NSE Nifty. Let’s get into the details of these share market indices.
Sensex is a blend of the two words - sensitive index. This stock market index was introduced in 1986, making it India’s oldest share market index. The BSE Sensex consists of the top 30 largest and most frequently traded stocks listed in the Bombay Stock Exchange (BSE). Since Standard and Poor’s (S&P), an international credit rating agency, licensed its technical expertise to BSE to construct the index, it is always referred to along with the S&P tag in its name.
Also known as the NSE Nifty, this index was first created in 1996. This share market index consists of the top 50 of the largest and most frequently traded stocks within the NSE. The NIFTY is owned and maintained by India Index Services & Products Limited (IISL), which is a joint-venture organisation between an Indian credit rating agency CRISIL and the National Stock Exchange. In fact, the CNX portion in the CNX NIFTY stands for CRISIL and NSE.
So, you’ve seen the answer to “what is a stock market index?” And you know the types of indices and what the benchmark indices are. But why do we need these indices?
To begin with, 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.
Let’s find out more about why stock market indices are required.
Many traders, investors and other market participants use the performance of the indices as a benchmark for analysing how their investments performed 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. This gives you a more accurate representation of the performance of your investments.
One way to outperform the market is by investing in indices through 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 a specific stocks, your corpus might be eroded if those stocks don’t perform well. With stock market indices, however, your exposure to risk is largely reduced.
Read How To Pick Stocks?
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. If this sounds like you, you could create a portfolio that replicates a stock market index, so you can reduce the costs of research and stock picking without compromising on the quality of your investments.
Stock market indices are extremely useful, and often, in times of market volatility, they act as a cushion for conservative investors. If you’re a beginner to the equity markets, it may be a good idea to start by learning about share market indices and testing the waters here, so you can get a better idea of how the markets work in practice.