The stock market index

The main purpose of a stock market index is to provide a means for measuring the overall trends in share prices in the market.

The stock market index is like an instrument that tracks the overall behavior of the stock market. It is basically an average of a carefully selected portfolio that represents, or almost represents, the whole market. The shares selected for inclusion in the index generally have a high floating stock which is held by the public, high market capitalization, high trading volumes, and high liquidity. The index is useful in that it gives you a quick fix on the market. If you want to know whether the market has gone up or down, or what the level of the market was one year ago, or five years ago, then all you have to do is to look at the movement of the index. You don't have to look at the price movements of each and every share listed on the market. The index, thus, represents the market.

The stock market index is also useful for comparing the returns you get from the stock markets with other assets, such as real estate, gold, collectibles, bonds, etc. Mutual funds use stock market indices for evaluating their portfolios. Some mutual funds have even floated index funds which mirror the composition of the index thus giving their investors returns similar to that of the index This happened when it was found in U.S.A that most mutual funds tended to under perform the index.

The most widely used stock market index in India is the BSE Sensitive Index, popularly known as Sensex. The BSE Sensitive Index was constructed in 1986, with 1978 - 79 as its base year. The value of Sensex in the base year was taken to be 100. Sensex is composed of 30 scrips selected on the basis of their size and daily trading volumes. Scrips are given weightage on the basis of their market capitalization (number of equity shares multiplied by their share price). The index is therefore extremely sensitive to changes in the share prices of the larger companies.

The other widely used index in India is the S&P CNX Nifty Index, popularly known as Nifty. This is the main index of the National Stock Exchange, The Nifty is composed of 50 stocks representing over 20 sectors of the economy, thus making it more broad based and diversified than the Sensex. Nifty stocks account for 65 to 70 per cent of the traded volumes on NSE.