Importance Of Stock Market Index: One of the most common ways of tracking the movement of the market is to track the movement of indices. When you read the term “The market is up”, what people refer to as “market” are actually the indices.
In India, we have two major indices that track the movement of the biggest stocks in the markets – SENSEX and NIFTY 50. But what makes indices so important and why do people follow them so closely?
Let’s understand the meaning and importance of stock market index.
Meaning/Definition of A Stock Market Index
A market index is a source of information, used to measure the fluctuations and movement in a particular sector within the market.
While SENSEX and NIFTY are used actively to measure the market as a whole, other indices are used to measure the movement of particular sectors such as banking and financial services (Bank NIFTY), BSE Metal Index, NIFTY Auto (Automobile Sector), NIFTY IT ( IT Sector), etc.
Types Of Indices
Here are the different types of stock market indices –
A sectoral index, present both in NSE and BSE, is used to measure companies within particular sectors. Bank NIFTY is an index for all the major banking stocks in NSE, and NIFTY IT is an index for the IT stocks such as Infosys, TCS, and Wipro.
While these indices exist in both NSE and BSE, it isn’t mandatory to mention the same companies in both indices covering the same sectors. A sectoral index gives you a general idea of how an industry has moved in the past.
Nifty 50 and Sensex, two of the most important indices in India, are examples of benchmark indices. Nifty 50 consists of the 50 biggest stocks whereas Sensex consists of the 30 biggest listed companies in the market.
They are known as benchmark indices because these indices are regularly monitored and rebalanced by the stock market exchanges with extreme scrutiny.
Not every large-cap stock is chosen to be a part of these indices so it is generally regarded as the most reliable source of information.
3. Market Capitalization
Some indices such as Nifty Next 50, Nifty 100, and Nifty Midcap 50 consist of stocks that fall into a particular market cap category.
By market cap, we mean the stock exchange market value of the listed company. For example, Nifty Midcap 50 is an index for the
50 midcap companies were selected based on NSE’s methods. It represents 6 percent of the free float market cap of the stocks listed on the NSE (NSE Nifty Midcap 50).
4. Other Types
Apart from the indices mentioned above, we also have a few more types of indices such as the Nifty 100, BSE 500, and BSE 100, which are much larger than the other indices and consist of stocks from diverse industries.
Due to the size of the index and the inclusion of different companies, it doesn’t fall into a particular type of index.
Importance of Stock Market Index
Stock market indices are quite important and they serve several purposes. One of them is to serve as a standard to measure the movement of the market or a sector.
Benchmark indices serve as a measure of understanding of the market as a whole because they include the biggest stocks in the Indian markets. Here are some points to better understand the importance of stock market index:
- Stock market indices are used to measure the movement of markets and sectors as a whole. They serve as a standard for a group of stocks or the market as a whole.
- Both investors and traders use indices to understand the current market condition and benefit from its movement. Investors study the markets to know the right time to buy or sell their stocks and traders use indices to trade futures and options.
- Besides retail investors and traders, FIIs, DIIs, and asset management companies use indices to manage the portfolio of their clients. Besides portfolio management, they also have to regularly rebalance the mutual funds managed by the AMCs as well.
- The stock market indices give the public an idea of the market sentiment at a particular time. Based on the market movements, traders and investors take action to make profits.
- Sectoral indices show the trend movement of specific sectors, instead of looking at all the stocks in that sector individually. This saves a lot of time and effort by giving a single-glance understanding of a particular industry.
- From indices, AMCs have created funds that have the same weightage as indices of sectors and benchmark indices as well. This allows investors to passively invest in index funds that track the market movement. Such funds move on par with their reference indices.
Why Are Indices Necessary For The Stock Market?
There are multiple reasons for having indices in stock markets. They help the entire investing community track the market without any complications.
Sorting the stocks based on sectors makes it easier to track sector-wise performance and identify trends in the market.
Also, by combining the best 30 or best 50 stocks in the market and tracking their performance, it gives an idea of how the market has performed so far, while also telling which companies are the biggest and most impactful in their industry.
The Two Major Exchanges In India – NSE & BSE
The National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) are the two major exchanges in India.
The Bombay Stock Exchange is one of the oldest exchanges in the world and also Asia & India’s oldest. BSE was established in 1875 by a Jain businessman named Premchand Roychand.
Most of the companies listed in the Indian markets are on BSE, with the figure in the range of 5,246 and upwards (As of February 2022).
BSE is located on Dalal Street, Mumbai, and is regulated by the Securities and Exchange Board Of India (SEBI). Besides being an exchange for companies to get listed, BSE itself is a publicly traded company.
After BSE, National Stock Exchange is the next major stock exchange in India. According to the official website, NSE is the fourth largest stock exchange in the world, by equity trading volume.
NSE was also the first Indian stock exchange to implement electronic trading. NSE’s headquarters are also located in Mumbai, India.
As we have mentioned above, the importance of stock market index is felt by every party involved in investing and trading. Indices are necessary to quickly understand and simplify the daily market movement.
Whether you are an investor or a trader, you need to understand the risks when investing and trading. To have an even better understanding of the markets, Fingrad has multiple courses to get you started from scratch.
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