Index, Indices. Have you been hearing it a lot? Well, then let’s talk about it. A stock market’s index means how investors feel an economy is faring. To be more specific, an index collects data from various companies across industries. All of that data put together makes a picture that helps an investor to compare the current prices with the past prices to calculate the market’s performance.
Here, some Indices concentrate on small subsets of the Market, like the Nasdaq index that closely tracks the technology sector. So, basically, if you want to know how technology companies are performing, you would have to look at the Nasdaq stock index.
Indices are also different in size. Some of them out there are tracking just a handful of stocks, and others looking at thousands. Every index serves a different objective because different investors and traders are interested in different sectors.
How is an Index Constructed?
Every stock market index utilized its very own proprietary formula when it determines which companies or other investments to include in it. Indices that measure the performance or broad spreads of the market will only have companies that rank highly in terms of market capitalization or the total value of the outstanding shares. On the other hand, they also may be selected according to an expert committee or simply represent all of the shares that trade on a selected stock exchange.
Once the indices manager has determined the companies to include, they need to determine how those companies are presented in the index. This is called index weighting. It all depends on the weight. The companies that are included in an index can have an equal impact on the performance based on share value and market capitalization. But you have got to know that even with weighting, there are types. We’ll talk about it all as we keep going.
Just like the different stocks and shares in the market – indices are spread out into types. Want to know them? Just read on.
Types of Indices
There are three main types of indices out in the market today, and they are mentioned here for you.
- Benchmark Indices
Nifty 50 is the combination of the 50 best-performing stocks. The BSE Sensex, on the other hand, is the combination of the 30 best-performing stocks. Now, you have probably heard these names much more than usual. It’s quite hard to set up a Nifty vs Sensex difference, since both of them serve the same objective and are called Benchmark indices. They are also the best practices that regulate the companies they pick. They are also known as the best point of reference for the market to operate in general.
- Sectoral Indices
Both – the Bombay Stock Exchange and National Stock Exchange have good indicators that measure companies falling under a selected sector. The Indices like S&P BSE Healthcare and NSE Pharma are known to be good indicators for the pharmaceutical sector. Another good example of this is the S&P BSE PSU, and Nifty PSU Bank Indices are some pretty good indicators of the public sector.
Both these exchanges don’t have to have corresponding indices for all of the sectors. But this is usually a significant cause.
- Market Capital Based Indices
A few indices choose the companies according to the market capitalization. Markey capitalization simply means the Markey value of a public traded company in the stock market. Indices like S&P BSE and NSE small cap 50 are a combination of the companies with a lower market capitalization, with the rules that have been set by the Security Exchange Board of India.
- Other Indices
Now that we know about the three main indices – let’s look a little more in-depth at the other indices out there. There are several other indices like S&P BSE 500, NSE 100, and more that are slightly larger and come with a more significant number of listed stocks.
Why Do We Need Stock Indices?
The stock market index functions as a barometer, indicating the overall state of the market. Investors use the stock market as a guide to determine which stocks to invest in.
The following is a list of the stock market index’s significance:
Serves as a Delegate
Investing in shares entails risk, and you must make an educated decision. Individual stock research may appear to be impractical. Indices assist in filling knowledge gaps among investors.
The Peer Comparison Parameter
Before you add a stock to your portfolio, you must determine whether it is worth the investment. A stock’s performance can be simply judged by comparing it to the underlying index. If a stock outperforms the index, it is said to have outperformed the index. It is deemed to have underperformed the index if it produces lower returns than the index.
Reflects Investor Attitudes
The Investor mood influences demand for a stock, which in turn influences the entire price. To buy in the appropriate stock, you must first understand why its price has risen or fallen. At this point, indexes can assist investors to evaluate their sentiment. You may even notice investor mood for a certain industry or across market capitalizations.
Assists in Passive Investment
Investing in a portfolio of assets that replicates the equities of an index is referred to as passive investment. Investors that wish to save money on research and stock selection prefer to invest in index funds.
Assists in Stock Picking
A stock exchange would have thousands of companies listed on it. Choosing the right stock for investment may appear to be a nightmare. You might not be able to tell the difference between equities if you don’t have a benchmark. Sorting the stocks at the same time gets difficult. It categorizes companies and their shares based on essential parameters such as company size, sector, industry type, and so on.
Now, you may have different investment needs, and this is a heads up. You cannot go according to those listed on indices. You have to do some intense research to know the right shares or stocks for you.
Final Takeaway
Indices of the market – to you right now, might just seem like an advantage. But that’s not true! It is not just an advantage but also a need. They help companies to make their investments much more safe and accessible. When there are indices, the pressure on investors and guides is reduced. Not just that, you also have to understand a lot more when it comes to investing.
