What Are Stock Market Indices?
If you switch to any business news channel and listen to stock market updates, one of the first few things you will hear is the rise or fall of Sensex or Nifty. But what is Sensex or Nifty? These are stock market indices. That brings us to the next question – what is a stock market index?
In this article, we will be looking at stock market index meaning, types of stock market indices, and the benefits offered by them.
What is a stock market index?
In the simplest terms, a stock market index is a statistical measure that reflects the changes in the underlying market. When a company issues shares, it lists them with a stock exchange. Every exchange has hundreds of listed shares. It creates a stock market index by selecting stocks that meet certain criteria. Indices can be made to reflect the entire market or a segment, industry, market capitalization, etc.
A stock market index offers a quick view of the average performance of shares that constitute the index. So, if the index rises, it implies that the prices of stocks in the index have increased and vice versa.
Types of stock market indices
There are various types of stock market indices based on the kind of stocks selected to constitute the index and the market segment that the index wants to focus on. Here are some popular types of stock market indices:
- Benchmark Indices: Two of the most popular indices – S&P BSE Sensex and CNX Nifty 50 are also known as Benchmark Indices since they reflect the performance of the BSE and NSE, respectively. Many mutual fund schemes and portfolio managers use these indices to compare the performance of their portfolios.
- Sectoral Indices: An index can be constituted to reflect the performance of stocks belonging to a specific sector. For example, the S&P BSE Healthcare Index has stocks from the pharmaceutical sector that are listed on the BSE. If you look at the performance of this index, you can get an idea about how the stocks of pharma companies have been performing.
- Market-Cap-based Indices: Some indices select stocks of companies across sectors but keep their market capitalization as the selection criteria. For example, the NSE Small-Cap 50 Index is a collection of companies that are defined as small-caps as per the guidelines offered by SEBI. If you are looking to invest in small-cap stocks on the NSE, then a quick look at this index can offer an estimate of the overall performance of such stocks on the exchange.
- Other Indices: There are various other ways in which stock market indices are created catering to the varying needs of investors. These can be thematic indices, broad-market indices, etc.
Also Read: Portfolio Investment
How does a stock market index help investors?
Here are some ways in which investors can benefit from a share market index:
- Benchmarking – Since indices represent a segment of the market, investors can analyze the performance of their investments compared to how the overall segment/s performed.
- Good for passive investors – Choosing the right stocks for investment can take up a lot of time, effort, and research. New investors can find the process of selecting stocks overwhelming. Indices offer a good option to such investors as they can replicate an index if they feel that its performance is as per their requirements.
- Indicator of market sentiment – Stocks generate capital gains if the demand for a specific stock increases and its market price rises. This depends upon the sentiment of the investors towards the sector and/or stock. Stock market indices help investors understand the overall market sentiment and assess the direction of the average prices of stocks to make informed investment decisions.
Also Read: What is Stock Market Trading & It's Settlement Process
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Frequently Asked Questions
Stock market indices are merely indicators of the performance of a group of stocks selected using certain criteria. While there are many indices, you can opt for the ones that are tracked by mutual fund schemes as benchmarks. It is important to remember that an index can only help you understand the average performance of stocks in the segment it tracks. Hence, if you are tracking a specific sector, it will be prudent to keep an eye on 2-3 indices around the said sector to get a fair view of its performance.
There are numerous stock market indices made to represent different segments of the market with different perspectives. As an investor, if you have an idea of the sector that you want to explore, then you can choose an index accordingly and start tracking its performance. Alternatively, you can start with broad-market indices or benchmark indices and work your way towards finding a sector that holds promise. We recommend that you talk to an investment advisor before making any investing decisions.