Indices are an important indicator to assess the sentiments of the stock market. When indices are up, it reflects the positive sentiments. And when they are down, it reflects the pessimism prevailing in the market. Considering that the stock market is the mirror of the economy, the indices are the direct reflection of the mood currently prevailing in the entire economy.
Many small stock exchanges operate independently in India from different cities. Yet, they do not have their own indices. Many important industries like banks, pharma, FMCGs etc., have their own indices, reflecting the mood of that industry at a given time. Yet, these industries are cumulatively presented by Sensex and Nifty and help in understanding the pulse of the overall economy.
How Is Sensex Calculated?
Established in 1875, BSE is Asia’s oldest stock exchange. Sensex is the most popular index under the BSE umbrella. Sensex is BSE’s benchmark index, consisting of 30 stocks from 12 different sectors.
Sensex is calculated using the free-float market capitalisation methodology. The level of index at any given time reflects the free-float market value of the 30 companies that are a part of Sensex.
Market Capitalisation is determined based on the following formula:
Market cap = Number of free-floating shares x Share price
Free float is a percentage of issued shares that are available for trade in the market. It excludes the shares of promoters, directors, board members and other major partner shareholders.
For example, if a company has issued 10 lakh shares, out of which 4 lakh shares are locked with promoters, then the remaining 6 lakh shares are considered free-floating.
How Is Nifty Calculated?
National Stock Exchange was established in 1996 to decrease the burden on BSE and divert the growing volume of trading. Nifty50 is the benchmark index under the flagship of NSE.
NSE’s calculation method differs from Sensex, majorly in two ways.
1) Nifty50 takes the top 50 stocks into the account as against 30 stocks taken by BSE, and
2) It is calculated based on the free-float market capitalisation-weighted method against the free-float method of Sensex.
The major difference here is that Nifty considers the total value of a company’s shares held by all investors, including the organisation. Whereas, Sensex considers only free-floating shares into account. In the weighted method, each stock is assigned weight while calculating the value of the index as per the total value of its outstanding shares.
Use of Indices
Indicator of Healthy Economy
Stock markets, and thereby the headline indices, are the symbols of a country’s financial infrastructure. The stock exchange is a true reflector of ups, downs in an economy and helps in gauging the current trends and shifts in consumer preferences. It tells about the direction that the country is moving in. Reading of the indices helps an analyst in differentiating between the old economy and new economy, and move their investments accordingly to benefit from the future trends.
A Never-Ending Source of Funding
The stock market is a platform that facilitates the buying-selling of securities. For companies, it is a direct source of securing their funding requirements from the public. As for investors, it is a highly convenient platform where they can easily sell their securities and liquidate their investments without being bound to any particular investment horizon.
Indicates the Latest Economic Trend
Indices are the true reflectors of the latest trends in the economy as it reflects the fundamentals of major companies and industries. Stock movement within indices makes it easier to understand which sector is finding favour among investors and help them in identifying stocks for investment.
Facilitates Peer Comparison
Apart from Sensex and Nifty, several sectoral indices are also available, which indicates the health of the companies within that sector. Nifty Pharma, Bank Nifty, FMCG, Realty etc., are examples of sectoral indices. Up and downs in these standalone indices help in analysing the current sentiments in those sectors and help in choosing the right stocks from within that sector.
What Impacts The Indices?
Movement in indices is the reflection of even minute changes in government policies and economic shifts. Indices mirror the market’s assessment of these changes on sectors as well as the fundamentals of individual companies. If indices react positively to a piece of news or event, it is passed on as a positive and vice versa.
The Shortcomings
Indices are often regarded as a barometer of the economy. However, it is made up of only a handful of companies. It leaves out a vast pasture of economy, which includes unlisted companies as well as MSMEs and unorganised market space. It also fails to co-relate with social infrastructure in the country as well as the income disparity among the various sanctions of the society.
That way, it fails to represent all aspects of the economy and misses out on signalling the stress beyond in the uncovered sections of the economy.
