BEGINNERS

MODULE-1
Basics Of Stock Market
Chapter-6
Stock Market Indices: Meaning and it’s Types

Stock market indices: an overview

Say it’s New Year’s Eve and you’re sitting with a bunch of your friends. After a
lot of pleasant banter, somebody eventually pops the obvious question, “So,
how was your year?”
How would you answer that? After all, it’s not easy to gauge each of the 365
days in the past year, isn’t it? Instead, you’re more likely to quickly whiz
through the bygone year in your head and revisit the important things that
happened to quickly assess what kind of a year you had.
Got a promotion, bought a new house and took that vacation of your dreams?
Well, in that case, you’ll perhaps tell your friend that you had a fabulous
year.
On the flip side, if you lost someone close to you, or had to move to a new
place you didn’t really like, you wouldn’t call your year so great.
So, essentially, the important events helped you assess how the year went,
isn’t it?
Similarly, moving on to the stock markets, let’s consider this question: “How
is the stock market behaving today?”
You see, there are thousands of stocks listed on the NSE and the BSE.
Clearly, it’s impossible to track the movement of the shares of each listed
company. A better approach would be to quickly look at the top few
companies on the exchange and track their movements.
If the shares of most of the top companies are on an upward trend, you’d
conclude that the markets were performing well that day. If, on the other
hand, they’re moving downward, you’d say the markets were performing
poorly. These top companies that you just picked, they’re what make up the
major stock market indices.
So, what is an index in the stock market?
Stock market indices are indicators that reflect the performance of the
market as a whole or of a certain segment of the market.

23
What is an Index?
A stock market index is a statistical tool or a statistical measure that
reflects the behavior of the market as a whole, or of a specific segment of
the market. Stock market indices are constituted by individual stocks. Some,
like the broad market indices, reflect the behavior of the market as a whole
since they take into consideration all the stocks, or the top stocks in the
market. Other indices may represent specific market segments like a sector
of the market. These are called sectoral market indices.
Market indices can also be composed of stocks of a certain market
capitalization. As the prices of the constituent stocks change, the index
value also changes. In this way, stock market indices help you understand
price movements in the market or a segment of it.
A stock market index consists of a group of companies whose shares are
traded on an exchange. Each index measures the price movement and the
performance of the shares of its constituent companies. This effectively
means that the performance of the index is directly proportional to the
performance of the stocks in the index. To put it simply, when the prices of
the stocks in an index go up, that index, as a whole, also goes up.
Okay then. We’ve now cleared up the answer to the question – What is an
index? Let’s get to know more about how indices are constructed. They each
consist of a specific number of stocks (such as 30 or 50 or 100). And they
include only the most well-established and financially strong companies
across various industries and sectors. This makes indices a fairly accurate
representation of the state of a country’s economy.
The two benchmark Indices in the Indian stock market
In India’s financial market, there are primarily two main indices:
❖ The S&P BSE SENSEX
❖ The CNX NIFTY.
These two are commonly known as broad market indices. Let’s delve a little
deeper to get a more thorough understanding.
S&P BSE SENSEX
Introduced in 1986, the SENSEX is India’s oldest index. It represents a group
of companies listed in the Bombay Stock Exchange (BSE). Here are some facts
about BSE SENSEX.
Standard and Poor’s (S&P), an international credit rating agency, licensed
its technical expertise to BSE to construct the index.
Therefore, the index is always referred to along with the S&P tag.
The SENSEX comprises the top 30 largest and most frequently traded
stocks within the Bombay Stock Exchange.

24
CNX NIFTY (NIFTY 50)
What is NIFTY 50? Also known as the CNX NIFTY, this index, which was first
established in 1996, is the National Stock Exchange’s (NSE) answer to the
SENSEX. This index, known also as the NIFTY 50, is a representative of a
group of companies listed in the NSE. Let’s take a brief look at some facts
about the CNX NIFTY.

• The NIFTY is owned and maintained by India Index Services & Products
Limited (IISL).
• The IISL is a joint-venture organisation between an Indian credit rating
agency CRISIL and the National Stock Exchange.
• As a matter of fact, the CNX tag in the CNX NIFTY stands for CRISIL
and NSE.
• The NIFTY’s constituents consist of the top 50 of the largest and most
frequently traded stocks within the NSE.
Other sector-specific indices
Since the SENSEX and the NIFTY cover multiple sectors of the economy, they
are considered to be broad market indices. However, both the BSE and the
NSE also have sector-wise indices that track the performance of particular
sectors or industries. These sectoral indices are also constructed in the
same manner as broad market indices.
For instance, BANK NIFTY is a sectoral index that tracks the performance of
the top 12 stocks from India’s banking sector. Similarly, BSE AUTO is
another sector-specific index that reflects the performance of the
automotive industry and consists of the top 15 stocks from that sector.

How are stock market indices beneficial to investors?

The performance of market indices is a fairly accurate indicator of the state
of the economy and of the general investors’ sentiments. Stock market
indices also provide investors like you with a wealth of information. You can
then make use of this information to formulate your investment strategy.
Here’s a brief glimpse at how indices are beneficial to investors.
They provide important information for benchmarking
As we’ve already seen, the movement and performance of indices tend to be a
true indicator of the overall trend of the stock markets. For instance, when
the indices are going up, the general consensus is that the investors and
market participants are optimistic.
That’s not all. Many traders, investors and other market participants also
use the performance of the indices as a benchmark for analysing how their
investments performed in the stock market.
25
For example, you can use the performance of an index like NIFTY for a certain
time period and compare that with the actual performance of your investment
portfolio for the same time period. This way, you would get a more accurate
and relevant representation of the performance of investments.
They help reduce your exposure to risk
As an investor, your main goal is to outperform the market. One way to do
that is by investing in indices via index funds, rather than in a single stock or a
set portfolio of stocks. Since indices contain stocks from a wide range of
sectors and industries, the risk of underperformance is lowered because of
diversification.
When you invest in a single stock, your capital might get eroded if that stock
doesn’t perform according to your expectations. However, with stock
market indices, the chance of all of its constituents going down at the same
time is very slim. Therefore, your exposure to risk is minimised to a large
extent.
Wrapping up
With this, our chapter on stock market indices comes to a close. So, now, if
you’re ever questioned about “what is an index” or “what is NIFTY 50,” you’re
well-equipped to answer those queries. In the upcoming chapter, we’ll get
into the details of what goes on in the front end of the stock markets.
A quick recap
• Stock market indices are indicators that reflect the performance of
the market as a whole or of a certain segment of the market.
• A stock market index consists of a group of companies whose shares
are traded on an exchange.
• Each index measures the price movement and the performance of the
shares of its constituent companies.
• In India’s financial market, there are primarily two main indices: the S&P
BSE SENSEX and the CNX NIFTY.
• The SENSEX comprises the top 30 largest and most frequently traded
stocks within the Bombay Stock Exchange.
• The NIFTY’s constituents consist of the top 50 of the largest and most
frequently traded stocks within the NSE.
• Both the BSE and the NSE also have sector-wise indices that track the
performance of particular sectors or industries.
• Indices provide important information for benchmarking and help
reduce your exposure to risk.

26
What are NSE and BSE?
What is NSE?
The National Stock Exchange, also known as the NSE, is a stock exchange
that came into being in the year 1992. At a time when physical trading was at
its peak, it was the first ever exchange in India to have introduced a fully
electronic mode of trading. Currently, the NSE is the largest stock
exchange in India in terms of trading volume. The National Stock Exchange is
well-known for its vibrant derivatives segment, whose trading volume
surpasses its equity segment. It even has its own index, the Nifty 50, which is a
compilation of 50 of the top companies listed in its exchange.
What is BSE?
The Bombay Stock Exchange, also known as the BSE, is India’s oldest stock
exchange, being established way back in 1875 itself. Although it was
established in 1875, the exchange was formally recognized by the Indian
government only in 1957. The BSE also came up with its very own electronic
trading platform – BOLT in 1995. In terms of the number of companies listed,
the Bombay Stock Exchange is bigger than even the National Stock Exchange.
Similar to the Nifty 50, the BSE also has its own index – the SENSEX. It is a
compilation of 30 of the largest companies listed in the Bombay Stock
Exchange.
How Does NSE & BSE Work?
The two stock exchanges work in quite a similar manner. Firstly, a company
makes an application for listing its shares on the stock exchange. This is
usually done as part of the company’s Initial Public Offering (IPO) process.
Once the application is approved by the exchange, the company’s shares are
listed on the exchange. This means the shares can now be bought and sold
freely.
Now, any investor interested in purchasing the shares of a listed company
places a buy order with their stock broker, who then forwards the same to
the relevant exchange. The stock exchange matches the buy order with a
similar sell order placed by another investor. Once the order is matched, the
transaction gets completed and the details of the completed transaction
are sent by the stock exchange to the clearing corporation for settlement.

27